BEIJING China needs to stay focused on taming inflation and raise interest rates by another 50 basis points even though its economy is slowing, the Organization for Economic Co-operation and Development (OECD) said on Wednesday.
In a biannual outlook, the Paris-based body said China needs to do more to calm price pressures because a weaker yuan has negated some of the impact of previous increases in interest rates and the reserve requirement ratio.
The OECD's reference to the yuan's weakness was premised on the currency's nominal effective exchange rate.
"With the economy slowing, there is a risk that authorities might not raise interest rates as much as needed and instead attempt to lower inflation rapidly through further price controls," the OECD warned.
"This would reverse progress in lessening state control of the economy and risk undermining longer-term growth," it said.
The OECD's hawkish stance on China, while not unique, contravenes the latest worry in mercurial markets that the world's second-biggest economy is most threatened by slowing growth, rather than inflation.
Beijing, on its part, has not voiced many concerns about a slowing economy, although it has in recent weeks wound down its strident anti-inflation rhetoric of past months.
The OECD did not say explicitly when China should raise rates, but implied this the hike should be in 2011 by saying that there is no need for further policy tightening in 2012.
It also urged China to let the yuan rise at a faster clip to rein in imported inflation.
Based on its assumption for more rate rises, the OECD forecasts China's annual inflation to average 4.6 percent this year, before pulling back to 3.4 percent in 2012.
The OECD's call for further policy tightening also led it to predict that China's economic growth will slow slightly to 9 percent in 2011, compared to last year's 10.3 percent. It believes growth will hit 9.2 percent in 2012.
Since Beijing made fighting inflation a priority in October, it has raised rates four times and ordered banks over eight occasions to lock up deposits which they would otherwise have lent.
That appears to have crimped the economy slightly for now, with April's factory output disappointing some investors. Price pressures have not slackened as far however, with April inflation running near three-year highs of 5.3 percent.
China has a 2011 inflation target of 4 percent, but many economists believe this is among some malleable objectives that the central bank can breach. For instance, Beijing has for years trounced its official economic growth target of 8 percent.
(Reporting by Koh Gui Qing; Editing by Ramya Venugopal)