Zhou Xiaochuan, governor of the People's Bank of China

China's central bank governor said on Monday that the modest revaluation of the renminbi announced last week was only an "initial" step, ading to speculation that the authorities will strengthen the currency further over coming months.

However, it is also reported that China won't make its currency fully convertible for at least five years because it worries hedge funds may force the yuan/renminbi to plunge, similar to what happened to the Korean won and Thai baht during the 1997 Asian financial crisis, said Li Deshui, a member of the central bank's monetary committee.

In his first public comments since China announced its long-expected shift in foreign exchange policy, Zhou Xiaochuan, head of the People's Bank of China, said: "We have made an initial adjustment of 2 per cent."

Zhou's comments are likely to be welcomed in Washington, where the Bush administration had been advocating a larger appreciation of the renminbi. However, Zhou said the shift was unlikely to have much impact on the US trade deficit. "China's exchange rate reform will not have too much influence on US deficits," he said.

Last Thursday, China raised the level the renminbi trades against the US dollar by 2.1 per cent to Rmb 8.11, and said the currency would now fluctuate against a basket of currencies.

By suggesting the possibility of further strengthening of the renminbi, China is hoping to limit additional political pressure but it risks stoking further speculative inflows in anticipation of a rise in the value of the renminbi.

Hedge fund threat

China won't make its currency fully convertible for at least five years
because it worries hedge funds may force the yuan/renminbi to fall, similar to what happened to the Korean won and Thai baht during the 1997 Asian financial crisis, said Li Deshui, a member of the central bank's monetary committee.

``There's more than $800 billion to $1 trillion of hedge funds in the world and the Chinese financial system is relatively weak,'' Li, 61, said in an interview. ``If the (yuan/renminbi) becomes fully convertible it would be attacked by these hedge funds.''

In 1997, Thailand's decision to let the baht fall, set off an Asian financial crisis and a wave of devaluations of other currencies in the region and in Latin America. China was the only major developing economy to maintain the value of its currency during the crisis, earning  praise from countries including the US and Japan that had feared any such move could trigger another round of competitive devaluations.

Li said that the state of China's banks is a key reason why the government won't allow the yuan to become a fully tradable currency anytime soon.

``Over the next five years, I do not foresee the renminbi becoming fully convertible,'' Li said at the weekend. ``Our banks are not good enough and the monetary system is not quite up to international standards.''

China's banks are trying to shed some Rmb1.59 trillion yuan/renminbi ($196 billion) in bad loans, a result of policy-directed lending to state-owned companies. They have also been ordered by regulators to raise their capital adequacy ratios to a minimum 8.0 percent by the end of 2006, when restrictions on foreign banks operating in China are lifted.