China is to try to improve the mechanism through which the local currency's exchange rate is decided rather than seeking a revaluation of the renminbi, a senior researcher said yesterday (May 17).

Li Yang, director of the Financial Research Institute of the Chinese Academy of Social Sciences, who also sits on the central bank's monetary policy committee, emphasized strongly at the CLSA China Forum 2004 yesterday the central bank's intention to improve the exchange rate mechanism.

"The exchange rate-forming mechanism is the key," he told the three-day forum that gathered together nearly 400 overseas fund managers and representatives from Chinese companies. "The market will tell us a level (of exchange rate), then that level will be the level," he said.

The Chinese Government has faced growing pressure to revalue the renminbi, which the United States and other countries have said is unfairly undervalued. China has resisted the pressures and pledged to improve its exchange rate mechanism and make it more flexible.

Foreign researchers, using highly-complicated models, have come up with various levels they think are appropriate for the renminbi's exchange rate - ranging from 7.2 to 1.9 yuan to US$1, Li said. "In my opinion, none of them is workable."

The exchange rate-forming mechanism includes the supply mechanism of foreign exchange, its demand mechanism, a foreign exchange market, a market-driven interest rate regime and a healthy financial system, and China has been making progress in all areas, Li said.

He also stressed that China's interest rate regime is different from other countries, and a so-called "interest rate rise" would not have an impact on the economy as broad as many think, or have the consequences an interest rate rise would bring in other markets.

Worries that China would resort to drastic tightening measures, including an interest rate rise, to cool down rapid investment expansion in certain sectors and allay inflationary pressures have caused stock markets to tumble during the past few weeks. But Li said investors were over-reacting.

"When talking about an interest rate rise in the United States, everybody knows it's the (Federal Reserve's target) Federal funds rate. But in China, you need to ask what interest rate," he said.

"And even when the circumstances justify an interest rate rise, it will not be a US-style one. It can be the lending rate, it can be the borrowing rate..."

Li said although China's accelerating prices were giving a reason for an interest rate rise, the sufficient liquidity at commercial banks and considerable interest rate differentials between China and the US did not support such a move at the moment.

Interest rates in China are already much higher than in the US, and a further hike would widen the difference and trigger greater inflow of speculative funds, which would then increase local money supply and fuel inflationary pressures, he said.

Foreign investors have been nervous during recent weeks that China may adopt a rigid policy to harness frenzied investment, and many have dumped their holdings of Chinese stocks.

The stock markets suffered an unusually abrupt tumble late last month as investors panicked over reports of a three-day loan suspension.

Editor: Donald