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From Reuters
Monday, April 10, 2006

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BEIJING -- China should push yuan reforms, let firms hold more
foreign currency, and raise gold reserves to help slow the rise in
foreign exchange reserves, an influential government economist said.

China should ideally hold about $700 billion in foreign exchange
reserves to ensure debt repayment, finance imports and maintain
stability, Xia Bin, head of the financial research institute at the
cabinet's Development Research Centre, said in a research report
seen by Reuters on Monday.

The rapid rise in China's reserves, the world's largest at $853.6
billion at the end of February, had made it hard for the central
bank to control money supply and showed that China had failed to to
keep badly needed capital at home, Xia said.

A spokesman at the State Administration of Foreign Exchange which
manages the reserves, declined to comment on the report.

The reserves have soared in recent years as the People's Bank of
China, trying to hold down the yuan, has bought most of the dollars
generated by a growing trade surplus and the inflow of foreign
direct investment and speculative capital.

Investing those dollars, China has become a big buyer of U.S.
government bonds and other dollar assets, helping to finance a heavy
U.S. current account deficit and to keep U.S. interest rates low.

"We cannot underestimate the possible loss to the reserves if, in
the long run, the United States adopts a weak-dollar policy and we
are still maintaining a high level of dollar reserves."

China is keen to hedge risk by diversifying its reserve holdings
away from the dollar, but economists say that fears of a collapse in
the U.S. currency will prevent any dramatic shift.

Xia suggested the government should consider a combination of
measures to slow down the build-up of China's foreign exchange
reserves, including giving the yuan more leeway to move.

The government should also consider allowing firms to hoard more
foreign currency and establish an investment fund to channel hard
currency and personal investments overseas, Xia said.

The central bank might need to raise its gold reserves, which had
been too low in recent years, to reflect China's status as a major
trading nation, he said.

Part of the forex reserves could be used to recapitalise state banks
following the injection of $60 billion into China Construction Bank
Corp., Bank of China, and Industrial and Commercial Bank of China,
Xia said.

"How to effectively ease the upward pressure is vital for the yuan
exchange rate reforms and also vital in resolving the problem of the
runaway growth in foreign exchange reserves," Xia said.

China must follow its own independent policy, regardless of foreign
pressure, by letting market forces adjust the yuan's value towards
its "equilibrium level", he said.

The authorities should keep the yuan's crawling appreciation
and "appropriately widen its floating band," Xia said.

In July China revalued the yuan by 2.1 percent against the dollar
and shifted to a managed float. The yuan has appreciated a further
1.3 percent versus the dollar since then and the pace of rises has
quickened in recent weeks, ahead of President Hu Jintao's visit to
the United States.