BEIJING, April 22 (Reuters) - China must take steps to rein in foreign exchange reserves to help curb inflation, including by making the yuan more flexible and gradually opening its capital account, a senior foreign exchange official said in published remarks.
But Guan Tao, head of the international payment department at the State Administration of Foreign Exchange, cautioned against any sharp currency rises.
"If we cannot slow the rise in foreign exchange reserves, our work to control consumer prices and property prices will be greatly undermined," Guan wrote in the latest edition of China Finance.
"Even if the property prices can be curbed, we cannot stop liquidity from shifting to other markets, brewing other forms of asset bubbles," he added.
China's foreign exchange reserves swelled by nearly $200 billion in the first quarter to more than $3 trillion, indicating hefty capital inflows given that China had a $1.02 billion trade deficit during the first three months.[ID:nL3E7FE19O]
The persistent increase in the foreign exchange reserves has been fuelling inflationary pressures in China, Guan said.
The rapid reserve build-up means the People's Bank of China keeps pumping out large amounts of yuan liquidity into the economy -- the root course of domestic inflation -- as the central bank has to buy most incoming dollars to slow the yuan's gains.
Guan said that Beijing's bid to boost the yuan's international status by expanding the currency's use in trade may lead to more money inflows at the initial stage.
China is pressing ahead with attempts to reduce its reliance on dollars in international trade.
But the yuan is used more often to pay for China's imports than its exports, so the central bank ends up accumulating even more foreign reserves -- mostly dollars -- because few trade partners now have enough yuan on hand to pay for Chinese goods.
This factor added roughly $40 billion to foreign exchange purchases in the first quarter, according to estimates by Mark Williams, China economist at Capital Economics.
Since October, China's central bank has raised benchmark interest rates four times and tightened lenders' reserve requirements seven times as it seeks to rein in loan growth and keep a lid on inflation. [ID:nL3E7FJ139]
Greater yuan flexibility will help rebalance the economy and curb bets on one-way yuan appreciation, Guan said. But he saw no basis for any sharp yuan appreciation, given that China's current account surplus has been narrowing.
"The yuan is getting closer to its equilibrium level as China's current account surplus is falling and capital outflows are rising," Guan said.
The yuan has gained 25 percent against the dollar since the 2.1 percent landmark revaluation in July 2005. Chinese officials have repeatedly ruled out another one-off revaluation despite foreign pressures.
Guan also repeated the official stance that Beijing would gradually open its capital account and expand more channels to facilitate capital outflows. (Reporting by Aileen Wang and Kevin Yao; Editing by Ken Wills)