BEIJING -- China needs to improve the flexibility of the yuan as part of financial reforms that should also include liberalizing interest rates, a deputy central bank governor said on Tuesday.

"To deepen financial reforms, we must make interest rates more market-orientated and make the exchange rate more flexible," Wu Xiaoling told a financial forum.

Many government economists have advocated a faster pace of appreciation for the currency.

They say that the People's Bank of China, by buying many of the dollars generated by China's large trade surplus and investment inflows, keeps the yuan undervalued, generating excess liquidity in the banking system that makes it hard for it to control money supply growth.

The yuan has gained a further 2.7 percent since Beijing revalued it by 2.1 percent and decoupled it from a dollar peg in July 2005 to float within managed bands.

Under this system, the yuan may rise or fall by 0.3 percent a day against the dollar from a midpoint set every morning by the central bank, but it has rarely come close to testing the limits of the band.

On interest rate reform, Wu said the People's Bank was making preparations to liberalize yuan deposit and lending rates.

On loans, commercial banks are currently free to charge as much as the market will bear but must charge at least 90 percent of the benchmark rates set by the People's Bank -- currently 6.12 percent for one-year loans.

On deposits, banks may offer as little as they choose but are limited to paying the maximum rate set by the PBOC -- 2.52 percent for one-year deposits.

"The central bank will steadily push forward the process to make interest rates more market-orientated, including simplifying the maturities on deposit and lending rates, and will make preparations to abolish limits on the spreads between lending and deposit rates," Wu said.