'China economy improving, rate hike a possibility'

Beijing: Interest rates in China are already on an upward trend as the economy improves, People`s Bank of China (PBOC) adviser Sheng Songcheng told Reuters in an interview.

"The economy is improving...so interest rates and prices will move in a positive direction," Sheng said on Thursday. "Under the right circumstances, if conditions allow, we can consider a rate hike."

After starting 2016 under a cloud, China`s economy has performed better than expected this year, fueling speculation that the central bank may be considering a policy shift after years of ultra-loose monetary conditions that have spurred an explosive rise in debt. 

Sheng said an increase in deposit and lending rates would serve to improve expectations for the economy overall, and also help stabilise the yuan exchange rate. 

The yuan is on course to be the worst performing major Asian currency this year and see its biggest annual loss against the U.S. dollar since 1994, with expectations for further declines next year. 

Sheng said China should use some of its foreign exchange reserves to support the yuan, but that the government should not lower the $50,000 annual foreign exchange purchase quota for individuals, which resets on Jan 1. 

"In the past two years depreciation pressure on the yuan has been high, but (China) hasn`t changed foreign exchange management rules. If you change the rules now, there will be market panic," Sheng said. 

"To stabilise the forex rate, you need to strongly emphasize to everyone, `I won`t change (the rules)`," he said.

Sheng, who previously was head of the PBOC`s Survey and Statistics Department, said that China won`t let the yuan depreciate too much, and that there was a strong possibility it would appreciate in the second half of next year. 

While inflation is showing signs of picking up in China along with economic activity, economists say there is no immediate pressure on the central bank to raise rates.

Growth in China`s producer price index (PPI) could surpass 4 percent in the first quarter of 2017 and 5 percent for the year, after ending nearly five years of deflation in September, Sheng added.

That should boost industrial companies` profits and give them more room to pay off debt.

Economic growth in China has been buoyed this year by stimulus in the form of record bank lending and higher government spending on infrastructure projects.

A housing frenzy has added fuel to the construction boom, though home prices and investment have shown signs of flagging in recent months.