The World Trade Organisation (WTO) on Wednesday stepped into the international tussle over China's exchange rate, saying looser controls could help Beijing fight inflation and avoid market distortions.
In a rare foray into currency issues, the Geneva-based trade body warned that if it did nothing, China risked higher inflation, stoked by capital inflows from its huge balance of payments surplus.
"A more flexible exchange rate regime could enable China to operate a more independent monetary policy, which would be better suited to ensuring a low and stable rate of inflation," it said in its first report on China's trade policy.
The WTO noted that China, which was admitted to the body in 2001 after 15 years of tough negotiations, was worried a more flexible currency policy could hurt economic growth and threaten macroeconomic and financial stability.
But efforts to "sterilise" the financial effects of the payments surplus by using monetary policy to mop it up were unlikely to be completely successful, it warned.
As a result, inflation would rise and this in turn would push up the real effective exchange rate.
"It would be better for the Chinese economy to avoid this higher inflation route to restoring external balance since inflation tends to distort markets," the WTO said.
The WTO said that while recent economic reforms had increased the market orientation of the Chinese economy, clearer investment and competition guidelines were needed to ensure a level playing field for the public and private sectors.
More effective enforcement of intellectual property rights, the subject of another big US grumble against China, was also important to ensure robust investment conditions, it said.
China's Commerce Minister Yi Xiaozhun, attending the WTO's first trade review his country's trade policies since it joined, promised members that Beijing would step up the fight against the illegal copying of foreign brand name goods.
Although he did not mention the currency, Yi said China was not seeking a trade surplus and was ready to work with trading partners for a better balance between exports and imports.
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