Chinese authorities are "on track" for a floating of the local currency, the yuan, sooner than most observers expect, according to Commerzbank.
Economists at the bank argue the recent massive inflow of capital into China, commonly referred to as "hot money," will force Beijing's hand to liberalize its exchange rate and capital account to deal with the sensitive issue of inflation.
Chinese inflation rose above 5% towards the end of last year before easing to 4.6% in December, with food inflation perched at around 10%.
Spiraling prices are a serious issue for any nation but particularly so for the one-party Chinese state, because of concerns that rapid inflation could incite social and political instability.
The high inflation has been partly blamed by analysts on the increased inflow of hot money, as foreign investors take advantage of interest rate differences and target short-term profits on their deposits.
The People's Bank of China has attempted to negate the surge in liquidity flows predominantly through raising lenders' reserve requirements, while it has also raised interest rates twice.
Economists at Commerzbank point out that the central bank's hands are tied to certain extent in its fight against inflation: raising interest rates further could lead to more hot money, as investors chase even higher returns.
There is also limited scope for soaking up liquidity through hikes in the reserve requirement ratio. The PBOC has already done this seven times over the past year and more hikes could damage banks' profitability.
"Thus, China cannot afford to wait too long before implementing capital account liberalization and, ultimately, moving towards a freely floating currency," the economists said.
The best way forward to control inflation, they say, is to let the yuan rise in value, which would then make imports cheaper.
Beijing should pursue a strong acceleration in capital account liberalization by early 2013 at the latest, according to Commerzbank.
"This is enough time to develop more sophisticated capital markets that can hedge FX [foreign exchange] movements, but not too late to stop a property bubble from damaging China's long-term development prospects," the analysts said.
Beijing has so far refrained from allowing a sharp rise in the yuan, fearing the impact it will have on the export industry. But the economists claim these fears will have subsided somewhat given the global economic outlook had brightened recently, even if uncertainty remains.
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June 05, 2026 16:18 ET A busy week for economic news flow saw a slew of reports being released that reflected the trends in the U.S. labor market. In Europe, economic growth and inflation data gained attention as the European Central Bank and Bank of England head for policy session later in the month. In Asia, the monetary policy session of the Indian central bank was in focus as the country, a major oil importer, reels under the pressures of a weaker rupee and rising inflation.