The irrepressible forces unleashed by China's boom are coming up harder and harder against the immovable object that is Communist command of the economy.

And the central planners seem to be bending, just a bit.

They are doing so unwillingly and they are not about to take universally proffered advice of unshackling the yuan and letting the market set the price of money, energy and other key inputs.

But at the margin, China's ever-mounting imbalances are forcing policy makers to take unpalatable decisions that, in the case of Wednesday's 10 percent rise in fuel prices, entail the embarrassing abandonment of a pledge given just a week earlier by Premier Wen Jiabao to freeze government-set prices till 2008.

As the problems become bigger, that will lead to more pressure for the authorities to give up some control over prices, be it energy or in other areas including the exchange rate, said Qu Hongbin, chief China economist for HSBC.

It's not that they're being proactive, but they have no choice. It's the pressure that is making them change, he said.

The increase in fuel prices aims to alleviate widespread shortages, especially of diesel, after soaring crude prices prompted refiners to cut output rather than swallow mounting losses by selling at the regulated, below-market prices.

The rise will add just 0.05 percentage point to consumer prices, the National Development and Reform Commission estimates.


Wen no doubt calculated that a bit more inflation and a loss of face was better than a lot more social unrest. One man was killed in a brawl in a petrol queue on Tuesday.

Still, the surprise announcement showed Beijing's economic policy makers to be at the mercy of events. Unusually, they had to act at a time not of their choosing.

Frank Gong, chief China economist at JPMorgan, said Wen had blinked.

The move last night apparently was forced on the authority after a big lesson: they cannot time the market, and the government has to do what is inevitable if it is serious on energy conservation, market-based mechanism and staying on the course of reform, he said in a note to clients.

The risk, economists say, is that China will be similarly unable to shape events in other spheres unless it acts more aggressively to reduce its economic imbalances.

These were highlighted by Wednesday's announcement of a 78 percent rise in the first-half current account surplus to $162.9 billion.

The biggest danger that many see is that of a stock market bubble. Aided and abetted by an abundance of cash and capital controls that close off investment alternatives overseas, the Shanghai market has risen sixfold in two years.

Qu at HSBC says Beijing's priority must be to deflate prices through tax measures and by permitting more capital outflows.

That would temper the pace at which China is accumulating foreign exchange reserves -- the root cause of the excess liquidity swamping the asset markets.

By doing that, economists say, China would eventually weaken an almost universal conviction that the yuan, or renminbi (RMB), is a one-way bet to keep heading higher.

The Chinese authority has to make a choice in the end: continue to tolerate asset inflation and in the end heading toward a huge asset bubble in years ahead, or allow RMB to appreciate faster to reflect its true value, Gong wrote.


Tantalisingly, the People's Bank of China, which keeps a tight grip on the yuan, has been doing exactly that since the Communist Party's five-yearly Congress ended last week.

The central bank on Thursday let the yuan reach its highest level, 7.4518 per dollar, since it was depegged in July 2005.

Ba Shusong, a researcher with the Development Research Centre, a cabinet think-tank, said the time was ripe for China to abandon what he called a passive, defensive financial policy stance now that it has gained more global economic clout.

Now we have to make preparations to take more initiative, to take a proactive approach, he said.

Right now, though, China has limited room for maneuver.

Take interest rates. China's rebalancing requires higher rates, to deter bank depositors from switching into stocks and to dampen speculative investment in industry and real estate.

But if China jacks up rates when U.S. rates are falling, the PBOC will start losing money on its operations to mop up foreign exchange inflows; overseas investors will also find it cheaper to borrow dollars to bet on rising yuan assets.

Ha Jiming, chief economist at investment bank CICC, expects the PBOC to raise rates for the sixth time this year to tackle inflation and sky-rocketing asset prices.

But the Chinese economy is increasingly integrated into the world economy. So looking forward, I think the room for further interest rate hikes becomes more limited in light of a decline in the interest level in the U.S., he said.

(Additional reporting by Zhou Xin and Lucy Hornby)