The warning the State Administration of Foreign Exchange made against currency speculation should not be interpreted as a late objection against the country's first interest rate hike in nearly a decade, which was made last week.

Instead, it highlights the need to carry on market-oriented adjustments of the broader monetary policies.

The country's foreign exchange regulator vowed on Tuesday to crack down on widespread illegal forex settlements, which were blamed as a scourge of unwanted hefty increases in China's forex reserves.

China's forex reserves jumped by 27 percent from the end of last year to US$514.5 billion at the end of September. Though the country's trade volume also soared at an even higher rate, its thin trade surplus actually contributed very little to the growth of foreign reserves.

Clearly, speculation over the revaluation of the renminbi has not lapsed in spite of the Chinese authorities' repeated pledges to keep its foreign exchange rate stable.

China's new external borrowings, excluding trade credits, surged by 97.8 percent on a year-on-year basis to US$83.4 billion during the first half of the year.

That implied some international hot money had, nevertheless, managed to work its way through the country's foreign exchange system into the domestic market, either to share the fast growth of the Chinese economy or to acquire renminbi-denominated assets in expectation of a possible revaluation.

A fund-thirsty developing country, China ironically has to worry about excessive forex inflow. Swelling foreign exchange reserves have forced the country's central bank to pump too much local currency into the overheating domestic market.

Given the risk of inviting more forex inflows, last week's interest rate hike was a tough but desirable decision the Chinese authorities made to combat domestic inflationary pressures.

The latest warning against currency speculation surely explains, in part, why the country's monetary policy-makers had avoided an interest rate hike for so long despite red alerts.

But after the monetary authorities had made the first crucial step to allow the market to play a bigger role in allocating financial resources, a comprehensive solution is urgent.

Illegal forex settlements are only a sort of means that speculators can exploit to circumvent administrative measures, imposing a big threat to the functioning of other market-oriented monetary measures adopted for the country's macroeconomic control.

To plug those loopholes, an introduction of more flexible and responsive market measures into the broader monetary policy has become a matter of urgency.

(China Daily November 4, 2004)