Any hasty decision to float the yuan could weaken the Chinese banking system and threaten the world economy, the chairman of the US Federal Reserve Alan Greenspan has warned.

Mr Greenspan said in a letter to the US Senate that flotation of the yuan, a move wanted by many in the US, could cause a heavy flow of capital out of China, which would in turn undermine Chinese banks and destabilize the world economy.

"Many in China fear that removal of capital controls that restrict the ability of domestic investors to invest abroad and to sell or to purchase foreign currency, which is a necessary step to allow a currency to float freely, could cause an outflow of deposits from Chinese banks, destabilizing the system," he said in the letter.

Financial instability in a big emergent economy, such as the Chinese economy, "would present a risk to the global economic outlook," he warned.

The letter, reported on the Wall Street Journal website on March 2, was published by US Senate Banking Committee chairman Richard Shelby, who had asked Mr Greenspan to expand on his views on the yuan.

The White House said it still wants China to move to allow its currency's value to be determined by financial markets despite Mr Greenspan's reservations about it, a spokesman said.

"Our policy remains the same. Our policy is very well known," White House spokesman Scott McClellan said in response to the Fed chairman's warning.

U.S. President George W Bush told Chinese Premier Wen Jiabao in December that the market should determine the yuan's value but the White House acknowledged at the time the transition would be a complex process.

The Bush administration believes the change would help boost exports for US manufacturers.

Many US companies want the yuan to be floated, arguing that the Chinese authorities have kept it artificially cheap in order to maintain a competitive advantage for Chinese exports.

With a US presidential election looming, outsourcing by US companies to manufacturers in China is a politically sensitive issue, as is the general problem of the US balance of payments deficit.

Mr Shelby had asked Mr Greenspan to elaborate on a speech he had made in December, arguing that the Chinese policy of pegging the yuan against the dollar risked causing inflation and eventually a recession in China.

Mr Greenspan said in his reply that China, before floating the yuan, had to tighten regulation of the banking system and its accounting practices and also had to provide them with government capital so that they had reserves for bad loans.

"More important, however, are steps...that create the financial discipline and incentives that are a crucial part of a viable credit system.

"Banks need to improve their lending decisions, internal controls, and risk management systems," he said.

Mr Greenspan said the Chinese government "seems to be moving to strengthen their banking system."

(China Daily March 4, 2004)