Feb. 18 (Bloomberg) -- China will shift focus to managing the yuan's exchange rate against currencies of its biggest trading partners and not just the dollar, allowing for a broader appreciation, former central bank adviser Li Yang said.

China's currency has fallen 6 percent against the euro since a link to the dollar was scrapped in 2005, prompting calls from European officials including French President Nicholas Sarkozy to allow faster gains. Some U.S. lawmakers also claim the yuan is kept undervalued to make exports competitive, and have threatened sanctions unless it extends a 15 percent gain versus the dollar since the peg ended.

There's a ``shift in how the central bank will be watching the rate and the focus of its policy target,'' Li, head of financial research at the Chinese Academy of Social Sciences in Beijing, said in a Feb. 14 interview. The central bank will focus on a trade-weighted ``effective'' exchange rate, he said.

Gains in the yuan against more currencies may help China slow growth in its trade surplus, which has flooded the economy with cash and driven inflation to an 11-year high. Gross domestic product grew 11.4 percent in 2007 from a year earlier, the fastest pace in 13 years, driven by exports and investment.

``Currency strength represents the pre-eminent monetary policy tool for the Chinese authorities,'' Dwyfor Evans, a strategist with State Street Global Markets in Hong Kong wrote in a research note today. ``Investors should brace for rising yuan volatility amid a more pronounced role for other yuan cross-rates.''

New Strategy

The yuan fell as much as 0.6 percent against the dollar on the first day of trading after a week-long holiday on Feb. 13, tracking declines in the euro and the yen. The currency rebounded as the China Securities Journal cited unnamed experts on Feb. 14 saying the central bank's focus will shift to the effective exchange rate.

The currency rose 0.28 percent to 7.1623 per dollar as of 5:30 p.m. in Shanghai, the highest since the end of the peg, according to the China Foreign Exchange Trade System. The yuan will rise versus some major currencies in 2008 and ``the overall effective rate will tend to be stable,'' Li said.

Since ending the peg, the People's Bank of China managed it with reference to a basket of currencies including the euro and the Japanese yen. The Westpac Nominal Effective Exchange Rate, a trade-weighted index for the yuan, has climbed 0.8 percent this year, a faster pace than the 3.5 percent gain last year.

Wider Trading Band

The government should widen the yuan's trading band, Yang Yuanjie, a scholar at the Finance Ministry's research institute, wrote in an article published yesterday by the Xinhua News Agency. The yuan is now allowed to fluctuate 0.5 percent against the dollar from a rate set daily by the central bank.

A stronger yuan would reduce import prices and slow growth in exports, helping to slow China's inflation, which was riding at 6.5 percent in December. The worst snowstorms in five decades closed factories and wrecked crops, adding to pressure on prices. The trade surplus jumped 23 percent in January from a year earlier and money supply grew at the fastest pace in 20 months.

``The PBOC has put exchange-rate policy before the interest rates when talking about this year's monetary policy,'' said Li, who formerly sat on the central bank's monetary policy board.

China needs more effective policies to stop the increase in the nation's $1.5 trillion in currency reserves from swelling money supply, according to the report by a group of researchers led by Li, published in Shanghai Securities News on Jan. 25. That may include setting up a special fund for currency market intervention, the report said.

A Group of Seven meeting in Tokyo kept up pressure on China to allow the yuan to rise faster as Canada and Europe complained their currencies are bearing too much of the dollar's decline. ``We encourage accelerated appreciation of its effective exchange rate,'' the G-7 statement said on Feb. 11.

``The government has begun to realize the importance of an effective rate versus major currencies,'' said Lian Ping, chief economist at Shanghai-based Bank of Communications Ltd., part- owned by HSBC Holdings Plc.

To contact the reporter on this story: Belinda Cao in Beijing at lcao4@bloomberg.net

Last Updated: February 18, 2008 04:51 EST