ANETTE JÖNSSON and ANNETTE CHIU

China's first interest-rate rise in nine years will be followed not only by further increases but also by a government move to allow a gradual appreciation of the yuan before the end of the year, according to Frank Gong, JPMorgan's chief China economist.

The move would happen through an initial 2 to 3 per cent widening of the trading band and would be coupled with the introduction of an onshore forward hedging market, Mr Gong said yesterday.

"Conditions are almost mature enough now for them to make a move towards more currency flexibility and it's the first time in two years that I can say that," he said, but stressed that it had to be a gradual appreciation.

"If they revalue in one big move, it will only inflate the bad loans and deflate the value of the banks' investments in US Treasuries. So, the government wants to allow Chinese corporates to hedge their books before they allow more appreciation [beyond the initial 2 to 3 per cent]," he said. Mr Gong forecast a further widening of the yuan trading band to a total of 7 per cent by the end of next year.

By allowing the yuan to appreciate, China will ease the inflationary pressure on the manufacturing side, which is mainly due to external factors such as high oil and commodity prices. More importantly, he said, the government needed to increase its flexibility on monetary policy.

Mr Gong said the key reason for China to raise rates was to keep real deposit rates in positive territory, which would discourage risk-taking and lending in the grey market in search for higher returns. A total rate increase of 1 percentage point in the next six months, including last week's rise of 27 basis points, should achieve that goal, he said.

Meanwhile, industry experts say rising interest rates will have a limited impact on China's demand for commodities, as the central government may loosen administrative controls while making more use of monetary policy.

Jun Ma, chief economist for greater China with Deutsche Bank, projected a further two to three increases - totalling 50 to 75 basis points - in the next 12 months to help bring inflation back to 3 per cent. However, he said the government would not announce any drastic measures to cool the over-heated economy.

Also, "about 60 per cent of China imports are for the production of export products, so China's cooling measures will only affect 40 per cent of its imports. The impact is not as significant as people had thought," Mr Ma told delegates at the International Dry Bulk Review conference yesterday.

China's contribution to world import growth would stabilise at about 25 per cent from 2006, he said.

Despite increasing rates, China's iron ore imports used for export products will remain strong. But with smaller growth in fixed asset investments, the growth in steel demand would slow marginally to 15 per cent next year, Mr Ma said.

The growth of fixed-asset investment is expected to slow to 17 per cent next year from 24 per cent this year.

A Cosco Shipping executive said energy shortages in China would fuel demand for coal and oil while infrastructure development would support the demand for raw materials. "I don't think freight rates will go down in the near term," he said.