Beijing is concerned that inflows of speculative hot capital are stoking inflation by increasing the supply of money and preventing it from raising rates, which are already significantly higher than elsewhere. After raising benchmark interest rates six times last year, the People's Bank of China has instead relied on credit rationing this year.

However, the country is under growing pressure to join fellow emerging market nations in raising borrowing costs to control inflation sparked by spiralling energy and commodity costs. India, Indonesia, the Philippines, Vietnam and Pakistan have raised rates.

'With inflation still higher than lending rates and interbank rates low, underlying conditions need to be further tightened,' the World Bank said in a quarterly report on the mainland economy. 'There is greater room to increase interest rates.'

Although mainland consumer price inflation is beginning to decline after exceeding 8 per cent during the first four months of the year, the World Bank said there had been some spill-over from higher food prices into wages and that pressure remained from rising industrial commodity and oil prices.

While speculation of further rate rises helped push inflows of hot money to an estimated US$40 billion in April, World Bank senior economist Louis Kuijs said the PBOC had done a good job absorbing the liquidity.

Mr Kuijs said there was little evidence that foreign cash had a serious inflationary impact.

'The [money] inflows have not overwhelmed policymakers,' he said. 'We do not feel China's monetary stance has been greatly affected.'

The issue became a wider concern in April when Zhu Baoling, the deputy chief of the State Information Centre's economic forecasting department, said hot money inflows had reached US$80 billion in the first quarter compared with US$120 billion for the whole of last year.

Although money growth remained under control, Mr Kuijs urged Beijing to loosen the exchange rate regime to give it more flexibility over setting interest rates. 'China is too large an economy not to have its own monetary policy,' he said.

On a nominal trade-weighted basis, the yuan has strengthened by less than 10 per cent against a basket of currencies since it was depegged against the US dollar in July 2005 - about half the pace of its appreciation against the greenback.

'The central bank folk know that sterilisation is not a solution, but only a temporary plaster, while the imbalances which cause the foreign exchange inflows are solved,' said Standard Chartered chief China economist Stephen Green.

But with real interest rates in negative territory, analysts said raising deposit and lending rates was needed to stem the more pressing issue of domestically generated liquidity.

Benchmark rates need to rise at least 50 basis points to control inflation and cut excessive borrowing, according to James McCormack, the head of Asian sovereign ratings at Fitch Ratings.

The World Bank has raised its consumer price index forecast for the year to 7 per cent and expects global inflation, affected by record oil prices, to remain a global problem for the foreseeable future.

Nevertheless, World Bank China chief David Dollar predicted mainland economic growth for the year at a healthy 9.8 per cent.

'Amid weaker and uncertain global prospects, China's growth will be supported by strong international competitiveness and a robust domestic economy,' Mr Dollar said.