ANALYSIS-Rally in tightly managed yuan shows China leery of FX reform
* China c.bank has allowed strong yuan despite weak exports
* Reform trajectory will not be "disturbed by outside noises" - c.bank researcher
* Regulators continue to manipulate the exchange rate through massive interventions
* Beijing offsetting strong yuan through other policy preferences for industries
SHANGHAI/BEIJING, Oct 17 (Reuters) - China's tolerance for a sustained yuan rally is reinforcing its commitment to wean the economy off of an export dependence, but unapologetic market meddling to hold back the pace of appreciation shows deep wariness of currency liberalisation.
The decision by the People's Bank of China (PBOC) to allow market forces to push the yuan up more than 2 percent against the dollar in 2013 has increased pressure on domestic exporters, who once relied on a weak yuan to boost price competitiveness, in support of efforts to restructure the economy to one that is led more by services.
But the tightly choreographed nature of the currency's rise undermines hopes that Beijing is finally ready to let capital flow freely in and out of the country, another area of reform high on the wish list of many Western nations.
China's foreign currency reserves exploded by upward of $163 billion in the third quarter of 2013, the largest absolute increase on record and the biggest percentage rise since February 2007. The increase reflects market intervention by the central bank to keep the yuan from rising too quickly, which could attract more speculative inflows.
"The PBOC has been purchasing foreign exchange at a frantic rate in recent weeks, underlining again how reluctant policymakers are to leave the renminbi in the hands of market forces," said Mark Williams and Qinwei Wang of Capital Economics, referring to the official name of China's currency.
"Among many other implications, this suggests that capital account liberalisation is a long way off," they wrote in a client research note.
China's traded exchange rate has set record highs against the dollar for four days in a row this week.
Traders said the central bank has appeared in recent sessions to suspend its use of intermediaries to quietly buy up dollars in the spot market, a practice that had effectively put appreciation on a leash in the spot market in the third quarter.
But traders say this reversal looks more like a tactical retreat - the dollar faced strong selling pressure globally amid the U.S. debt-ceiling showdown - rather than a shift towards letting market forces set the yuan's value.
The rally occurred despite export data showing an unexpected 0.3 percent annual decline in September, which confounded market expectations for a 6 percent rise. Recent comments though by the central bank indicate that investment-related capital inflows, rather than the trade surplus, is the source of upward pressure on the exchange rate.
Central bankers have insisted they are committed to reducing currency intervention.
"The central bank is already on its reform trajectory as scheduled and will not be disturbed by outside noises," said a senior central bank researcher, who asked not to be identified because he is not allowed to speak to the media.
"It is impossible and unrealistic to keep adjusting our foreign exchange rates solely following export figures."
Central bank Deputy Governor Yi Gang said in March that China had reduced its intervention in the market and that currency policy would be more flexible in 2013.
But the currency reserves data shows that the bank has continued to intervene as it sees fit to prevent undue fluctuations in the exchange rate.
At the same time, suggestions by regulators that the PBOC would widen the yuan's 2 percent trading band to allow more volatility into the market sometime during the summer have led to disappointment; apart from this week's rally, intraday volatility has been minimal since August, which traders say is due to intervention.
Multinational firms are eager for Beijing to make it easier to repatriate their China earnings back to headquarters, but many domestic economists share Beijing's caution about yuan liberalisation.
"I am a very strong reformer except for capital flows, and that should not be equated to pro-reform or not pro-reform," said Wang Tao, an economist at UBS.
"I would think the biggest reforms are to the domestic financial system, domestic state-owned enterprises, pricing systems, fiscal systems; those are very important. In the mean time, having some sort of insulation between domestic issues and external shocks by maintaining controls on short-term capital flows is a good thing."
She points to the fractious state of a U.S. political system that saw American lawmakers contemplate defaulting on outstanding debts in the service of a purely domestic policy debate. China is one of America's biggest creditors.
That reinforces the long-term case for currency reforms, which would reduce China's dependence on the dollar, Wang argues. But it also supports those who say retaining short-term controls will prevent money from washing in and out of China willy nilly while its economic recovery remains delicate, she said.
RESISTANT TO CHANGE
So far, the economy's growth drivers have not shown signs of any fundamental shift, even with the yuan strengthening by 4.43 percent over the past two years.
Economists polled by Reuters expect data on Friday to show little adjustment in the ratio between retail sales and fixed-asset investment, which some use as a proxy for China's progress in economic restructuring.
For the central bank, government measures to support a slowing economy have bought time by satisfying some Chinese managers that a strong yuan will not lead to immediate bankruptcy because Beijing will help them in other ways.
"As far as my company is concerned, I think we can accept the appreciation pace of the renminbi this year," said Ye Xiangyu, general manager of People Electronic Appliance Group in Wenzhou.
"I would rather focus on the government's supportive measures than on the movements of the foreign exchange rate."
(Editing by Neil Fullick)