"Financial institutions will, from now on, be able to set their foreign currency lending rates in line with the international market," theapex bank, People's Bank of China said in a circular.

The circular issued yesterday by the Bank says the lending rate of foreign currencies will be liberalised.

Financial institutions are authorised to define by themselves the lending rate and interest settlement patterns of foreign currencies according to the fluctuations of interest rates in the international Financial market, as well as financing costs and risks.

At present, loan rates at Chinese banks are permitted to float only 10 per cent above or below a base level set by PBOC, China Daily noted while describing the currency relaxation as "a major step forward in the liberalisation of its tight interest rate system."

PBOC has pegged the yuan to the US Dollar within a narrow band of around 8.26 yuan to a dollar. China also has foreign exchange reserves of more than 158 billion dollars, the second largest in the world after Japan.

A PBOC spokesman said the new move aims to promote a market-oriented interest rate reform so that China's banking ndustry will open wider to the outside world.

PBOC governor Dai Xianglong had said in July that China's interest rate system would be relaxed over the next three years to allow the market to decide deposit and lending rates. The interest rate of foreign currency deposits equivalent to three million US dollars or over will be decided through negotiations between financial institutions and their clients.

According to the circular, the interest rate of petty foreign currency deposits will be designated by the China Association of Banks (CAB) as a unified rate to be carried out by all financial institutions.

The official newspaper, quoting sources said that China would first allow the market to set foreign exchange rates, which are sensitive to changes in the international currency market.

This would be followed by the liberalisation of the Chinese yuan which is believed to occur in two or three years time, Wang said.

Since May 1996, China has effected cuts in its interest rates seven times, which did lead to some expansion of the economy, but the impact was not as strong as expected.

Bankers, entrepreneurs and experts have often complained about the fixed currency rate as it leads to an unbalanced relationship between money supply and demand, which does not go well with a market-oriented economy, the report said.