BEIJING China will press ahead with reforms to allow more flexibility in the yuan's exchange rate and the remaining barriers to creating a cross-border currency trading zone could be cleared in the first half of this year, senior officials said on Wednesday.
Yi Gang, deputy governor of the People's Bank of China, reiterated Beijing's commitment to currency reform on the sidelines of the annual meeting of China's parliament, the National People's Congress (NPC).
"We will continue to reform and open up. I'm confident that the renminbi (yuan) exchange rate will be more balanced and flexible and basically stable," Yi, who also heads the State Administration of Foreign Exchange (SAFE), China's FX watchdog, told reporters on the sidelines of the NPC.
Sources with knowledge of the latest PBOC thinking have told Reuters that China is set to use swelling offshore holdings of its tightly-managed currency worth around 1 trillion yuan to justify a landmark shift in tactics to relax capital controls.
Separately Zhang Ping, head of the National Development and Reform Commission (NDRC), the country's top economic planning agency, told an NPC news conference that plans for China's currency trading pilot programme were progressing smoothly.
Zhang said only six of 22 measures needed to get a $45 billion special economic foreign exchange trading zone up and running in Qianhai, near the border with Hong Kong, were outstanding and likely to be resolved in the first half of 2013.
"We are hopeful of coming up with plans to solve those problems in the first half of this year," Zhang said.
Outstanding issues included ones related to legal practices, given differences in the judicial systems of the mainland and Hong Kong - a special administrative region of China governed under the principle of "one country, two systems".
China set up the Qianhai business zone offering freer currency movements and Hong Kong professional standards last June. The government released rules in December for companies that incorporate in the area to borrow yuan loans from Hong Kong banks with interest rates and tenors to be fixed independently.
RISING YUAN DEMAND
The PBOC's Yi also remarked that the yuan was close to its equilibrium level and reiterated the central bank's assertion that it has cut intervention in the foreign exchange market.
Both points emphasise the stability that Chinese policymakers want to ensure even as they try turn the yuan into a more freely-traded currency.
Official remarks that the yuan is near its equilibrium contrast with data this week suggesting that demand for the yuan may be rising again as China recovers from last year's economic downturn, the worst in 13 years.
The yuan hit a seven-week high on Wednesday, a day after data from the People's Bank of China showed China's central bank and commercial banks bought a record 683.7 billion yuan worth of foreign exchange in January.
Economists say the all-time high purchase indicates capital is flowing back into China, although Central Bank Governor Zhou Xiaochuan downplayed the idea when asked on Wednesday.
"You can't draw any conclusions from one months' data. The volume every day is very high," said Zhou, also speaking on the sidelines of China's parliament session. "Sometimes there is more demand for renminbi and sometimes for foreign exchange."
Large foreign exchange purchases by China's central bank and commercial banks amount to base money creation and can fuel inflation in the country unless the People's Bank of China soaks up the excess yuan injected into the system via sterilisation.
In reference to that, Yi said China would use open market operations including purchase agreements and central bank bills to mop up excess liquidity stemming from foreign exchange inflows.
SAFE had said last month that China faces greater risks in capital inflows and outflows this year, against a backdrop of economic uncertainty worldwide.
Ting Lu, an economist at Bank of America-Merrill Lynch, said the record purchases of foreign exchange in January showed pent-up demand for the yuan as confidence in the world's second-largest economy rebounds.
But Lu said he did not think large foreign exchange purchases would be sustained as China's central bank has clearly signaled that there is little room for the yuan to rise further.
"The room for further yuan appreciation against the dollar is limited, as is signaled by the People's Bank of China's recent interventions," he said.
Despite the central bank's declarations that it has reduced its foreign exchange interventions, currency dealers say they still spot aggressive buying or selling of dollars by authorities.
China wants to turn the yuan into a convertible, or less controlled, currency that becomes a major medium of exchange in global commerce and one day would rival the dollar as an alternative investment in government reserves.
(Reporting by Kevin Yao, Steven Bian, Lucy Hornby and Cao Weihao; Writing by Koh Gui Qing; Editing by Nick Edwards and Jacqueline Wong)