The heretical talk started with the publication of a paper by Tan Yaling, a senior analyst with Bank of China (BOC) on May 6. The fast appreciation of the yuan was now beyond the country's "bearability", Tan said, and was becoming harmful to the short-term stability and long-term development of the economy. She said the government should consider taking a "one-step" measure to significantly devalue the yuan at "an appropriate time" so as to disillusion the market's expectations of a continuous appreciation of the currency.

State-controlled BOC is the country's major foreign currency bank Tan's report was for this reason immediately read as an official message that the government was testing the waters before doing something to curb yuan appreciation. Tan's argument appeared in particular to be echoing concerns recently publicly expressed by senior financial officials such as central bank governor Zhou Xiaochuan, about inflows of speculative money betting on further yuan appreciation.

The stock markets on the mainland and in Hong Kong reacted promptly. On May 7, Hong Kong's benchmark Hang Seng Index dropped 2.48% to close at 25,610. Share prices of leading Hong Kong-listed mainland enterprises shed more than the average. The benchmark Shanghai Composite index plunged 4.13% to close at 3,579. The markets remained weak in the remaining days of last week.

The yuan, whose rate of appreciation had slowed in previous days, reversed direction on May 8, with the official exchange rate down 162 basis points to 7.0010 yuan to one US dollar. This was the third-largest one-day decline since July, 2005 when China changed its fixed exchange regime to allow the gradual revaluation of the yuan by linking it to a basket of hard currencies instead of the US dollar alone. The yuan previously traded at about 8.3 to one US dollar.

The two largest single-day drops were on April 14 and 15, 2006, when the yuan shed 200 and 225 basic points respectively. In off-shore trading, the one-year non-delivery forward (NDF) rate dropped 1.24% to 6.6040, compared with 6.2 at the end of March.

BOC waited two days after Tan's report before issuing a clarification, with BOC spokesman Wang Zhaowen saying in Beijing on May 8 that "the research only presents the personal view of Tan Yaling, which does not represent the view of Bank of China."

He could have well added, "Even if it is the BOC view, it does not represent the Chinese government." For, although still controlled by the state, BOC is in fact pretty much a commercial bank.

Certainly, the Chinese government could intervene in the market and change the exchange rate of the yuan at any time, since it still holds tight control. But there are ample reasons to believe that Beijing would not take this course, although it did take a big devaluation 14 years ago in different circumstances. The yuan has gained 18% since the mid-2005 reform and 4% this year.

Peng Xiangdong, deputy general manager of the Agricultural Bank of China's international business department, told reporters: "BOC's interpretation may not be accurate. A 'one-step' devaluation for the yuan is impossible. There are market mechanisms which will pay their roles. Moreover, the Chinese government has repeatedly stated it would not let the yuan devalue."

In Peng's view, the yuan gained fast in the first quarter simply because of the sharp devaluation of the US dollar. As the greenback rebounds, the yuan appreciation will also slow down.

Internationally, China still faces growing pressures from its major trade partners, the United States and EU in particular, to speed up the yuan revaluation. A new round of Sino-US strategic economic dialogue will be held next month. As in the past rounds, the US is expected to press on faster yuan revaluation. Any move to deliberately devalue the yuan could inevitably sour China’s trade, and even political, relations with its main trade partners, which may be the last thing Beijing wants right now.

Domestically, the Chinese government sees inflation as public enemy No 1. The rising prices are partially imported due to higher costs of commodities, raw materials and energy on international markets. Any significant depreciation of the yuan, while of possible help to some export-oriented manufacturing industries, would further fuel inflation, making the government's task a "mission impossible”.

Even with the gradual revaluation of the yuan, inflation is picking up pace. The Consumer Price Index (CPI) rose 8.5% in April year on year, the National Bureau of Statistics (NBS) said this week. NBS chief economist Yao Jingyuan admitted that the government’s target to control CPI growth at 4.8% for the whole of this year "is quite difficult".

Technically, to make "one-step" devaluation, there must be a target. So what target should be set for the devaluation, 7, 8, 9 or 10 yuan to one US dollar?

In 1994, when C ้hina made a "one-step" depreciation of the yuan, the official exchange rate was about 5.8 yuan to one US dollar, while the black market rate was 8.7. Zhu Rongji, the then vice premier overseeing economic affairs, in a bold stroke scrapped the artificially fixed official rate and adopted the black market rate as the exchange rate for the yuan. In his view, the black market rate reflected the true value of the currency.

Now the market tends to see the true value of the yuan as higher than the current level. Yet Tan thinks it should be much lower, so she should at least tell people (or the Chinese government) of the target in her mind.

Since it is a long-term trend for the yuan to continue going up provided the Chinese government does not intervene as Tan suggests, then another question can be raised: when will the period of yuan appreciation come to an end?

Many Chinese economists thinks the officially-fixed exchange rate of 5.7 in 1994 may now reflect the yuan's true value, after 14 years of high-speed economic growth in the country.

"Therefore, a general view now is that the current expectation on yuan appreciation will last until the the exchange rate of the yuan to the US dollar goes to below 6," wrote Ding Zhijie, a professor with the University of Foreign Economic Relations and Trade.

All this said, Tan’s report has made a good point: the Chinese government is deeply concerned with what it sees the continuous inflow of international "hot" money to speculate on the yuan. This further increases the pressure on yuan appreciation. Moreover, once such speculative money begins to pull out of the country on a large scale, there could be problems.

The amount of international "hot” money is about US$650 billion this year, which could grow to $800 billion within 12 months, according to a recent report by Zhong Wei, director of financial research center under Beijing Normal University.

A better way to deal with the consequences of "hot money'' inflows than manipulating the exchange rate was proposed in Shanghai last week by Joseph Yam, chief executive of Hong Kong Monetary Authority. The central government, he said, should speed up liberalization of the yuan on the capital account so that mainland companies and individuals could freely exchange their yuan capital into foreign currencies and make investments in overseas markets. The subsequent outflow of funds would counterbalance the inflow of "hot” money and effectively reduce the pressure on yuan appreciation.