Reform of the exchange rate regime on the Mainland should follow a gradual path. There is no need to take risks on the exchange rate front.

This was the message from Monetary Authority Chief Executive Joseph Yam in his latest Viewpoint column posted on the authority's website today.

At the authority's Sixth Distinguished Lecture last week, People's Bank of China Governor Zhou Xiaochuan on September 18 argued for gradualism, pointing to the need to tread carefully to avoid destabilising mishaps.

Mr Yam agreed with Governor Zhou in taking a gradual approach in the reform of the exchange rate regime and the balance of international payments on the Mainland.

"It is true that there has been substantial capital inflow into the Mainland, leading to a very rapid accumulation of foreign reserves. I believe Mainland authorities are well aware of the risks of this, in terms of, for example, an asset price bubble that could prove to be quite destabilising to the financial system when it bursts."

But Mr Yam said the Mainland had made significant efforts to deal with the inflow.

"Under the present exchange rate system, the accumulation of foreign reserves is matched by an increase in the RMB monetary base that needs to be sterilised if the undesirable consequences on credit expansion are to be contained.

"The programme for the issue of central bank bills introduced a few months ago has produced a sterilisation effect of over RMB 400 billion, or an equivalent of US$50 billion of net inflow."

There is scope for securitisation of these loans to produce more financial instruments for money market operations. There is the option of changing the reserve requirement, which was invoked last month when the ratio was increased from 6% to 7%.

"There is the option of making changes to interest rates to discourage further inflow, but obviously this may have undesirable effects on the asset markets. And there is the option of opening up relief valves in the capital account. There is no need to take risks on the exchange rate front."