March 5 (Bloomberg) -- China's government will make the yuan more flexible, central bank Governor Zhou Xiaochuan said, a commitment that may help the Bush administration fend off calls in the U.S. for trade sanctions against the nation.

Premier Wen Jiabao's pledge to improve the currency system this year ``means that the government will add more flexibility to the exchange rate,'' Zhou told reporters during the National People's Congress in Beijing today. The government may widen the yuan's daily trading band, Zhou said, without giving a timetable.

Lawmakers in the U.S., Europe and Japan say the yuan is undervalued, giving Chinese exporters an unfair price advantage. China's trade surplus tripled to a record $102 billion last year, helping to drive a 9.9 percent economic expansion, the fastest among the world's major economies.

The yuan has gained less than 1 percent since China revalued the currency and ended a decade-old peg to the dollar on July 21. China's government started managing the yuan's value against a basket of currencies, allowing it to move by as much as 0.3 percent against the dollar either side of a daily rate announced by the central bank. In practice, the yuan's biggest daily swing has been less than a third of the maximum.

``It's a natural step for the country to gradually widen the trading band,'' said Ha Jiming, chief economist of China International Capital Corp. in Beijing, who forecasts the band will be widened to 1 percent this year. ``Conditions in China are mature enough for this to happen.''

Sanctions Threat

The yuan, a denomination of China's currency, the renminbi, Was little changed at 8.0365 to the dollar in New York. Its value was reset at 8.11 to the dollar on July 21, a 2.1 percent appreciation from the level where it had been held since 1995.

``We will improve the system of managed floating foreign exchange rates and keep the renminbi exchange rate basically stable at an appropriate and balanced level,'' Wen said in his annual report to China's parliament today, in a section listing the government's major tasks for this year.

Any decision to widen the trading band will depend on demand from the international market and China's domestic needs, the central bank's Zhou said. The current trading band against the dollar is ``appropriate,'' he said.

``It's clear that they're letting the yuan appreciate,'' said Firas Askari, head currency trader at BMO Nesbitt Burns in Toronto. ``The Chinese will let it as long as they don't feel pressured.''

Free Flow

U.S. Treasury Secretary John Snow, who opposes the tariff legislation, is pushing China to loosen controls on the yuan. Protectionist measures against China would risk undermining U.S. efforts to promote the free flow of goods and services around the world, Snow said in a March 3 speech.

``China needs to recognize that those of us who make the case'' for free trade ``need some help and support on their side,'' Robert Zoellick, the deputy secretary of state, said in an interview last week.

Lindsey Graham, a Republican senator from South Carolina, and Charles Schumer, a Democrat from New York, are sponsoring legislation that would impose tariffs on Chinese goods unless the yuan is allowed to rise more rapidly.

China won't reduce its U.S. dollar holdings, even as it changes the makeup of the nation's foreign-exchange reserves, Zhou also said.

The central bank is ``adjusting'' the reserves based on international market conditions, he said. Dollar assets won't be reduced because the reserves are continuing to grow as the central bank changes the mix of its existing portfolio, he said.

Surging Reserves

China's foreign-exchange reserves jumped by a third to $818.9 billion last year, almost matching those of Japan, the world's biggest holder. China's purchases of U.S. Treasury securities have helped to hold down U.S. interest rates and sustain consumer spending in the world's biggest economy.

The ending of the peg fueled speculation that China might slow purchases of the U.S. dollars that it used to keep the exchange rate stable.

China's holdings of U.S. Treasury securities were $249.8 billion as of November. About three-quarters of the reserves are probably held in dollars, according to Stephen Green, a Shanghai-based economist at Standard Chartered Plc.

China plans to ``optimize the structure'' of its reserves and ``actively explore'' ways of investing foreign exchange more efficiently, Hu Xiaolian, director of the State Administration of Foreign Exchange, a central bank unit that manages the reserves, said in a statement on Jan. 5.

Zhou said the foreign-exchange administration adheres to three principles in managing the reserves: ensuring safety, maintaining liquidity and increasing value.

He declined to comment on whether the central bank will raise interest rates this year. The bank will monitor economic conditions and inflation, he said. The benchmark one-year lending rate is 5.58 percent and was last raised in October 2003.

To contact the reporter on this story: Tian Ying in Beijing at ytian@bloomberg.net; Yanping Li in Beijing at Yli16@bloomberg.net

Last Updated: March 6, 2006 09:55 EST