One of the major observations we would make on China is that policy-makers in the country are not given sufficient credit for managing and reforming an enormous, rapidly-expanding economy. Far too often, the debate in the West is dominated by simplistic and shrill cries for China to allow its exchange rate to appreciate because it is supposedly undervalued, and demands that it properly opens domestic markets to foreign competition. As always, the situation is much more complex.

Right now, and for the foreseeable future, China's major policy challenge is not the exchange rate, but the dramatic acceleration in wage and price inflation. A report released today by Fortune Weekly claims that average salaries in China rose by 7.9% last year, with an even larger increase expected in the current year. Productivity growth may well be stronger than in the West but, even so, it is likely that relative unit labour costs in China deteriorated last year. In the US for instance, real unit labour costs fell in 2010 by around 2%. In other words, Asia's largest economy appears to be losing some of its competitive edge.

Living expenses in China have soared over recent years, reflecting the surge in property, food and energy prices. China's inflation rate, officially 5% but likely nearer 7% - or even 8% - is well above that of the US, where it is barely 1%. It might surprise many in the West but price levels in China have rapidly caught up to those in many advanced' economies. For example, a small brand-name frappuccino in China now costs 30 yuan, or around £2.87. Here in the UK, the same delightful beverage costs £2.75. China is not cheap any more. By extension, it could be argued that the currency is not particularly undervalued either.

Chinese officials are no doubt conscious that the country's competitive advantage is wilting, which partially explains their hesitancy in terms of allowing the yuan to appreciate significantly. Notwithstanding the huge trade surpluses that China recorded last year, it is likely that the country's terms of trade is worsening. With domestic demand soaring in response to rapid wages growth and abundant liquidity, import prices climbing fast (especially for important agricultural and energy-related commodities), and exports slowing, China's authorities understand that the trade dynamics for the economy are likely already worsening.

Complicating China's exchange rate-management has been the extraordinary capital inflow into the country, attracted by the expectation of both healthy investment returns and an appreciation in the currency. Desperate to contain this explosion in liquidity and the subsequent inflationary pressures, the PBOC raised the reserve ratio requirement (RRR) for major banks on six separate occasions last year. Just this morning, it has announced another 50bp increase in the RRR to 20% from 20th January. The Chinese central bank has also been raising rates, but frankly it has a long way to go before interest rate increases have much impact on inflation given the very negative real interest rates that exist currently.

China absolutely understands that opening up both the current and capital accounts is integral to internationalising the yuan and increasing its acceptance as a potential reserve currency. Notwithstanding China's increasingly dominant position within the global economy, its currency unfortunately lags a long way behind, but it will catch up quickly. Yuan deposits in Hong Kong are doubling every three months; China is increasingly clearing trade transactions with major trading partners such as Russia and Turkey in local currency rather than involving the dollar; China is starting to allow residents to purchase foreign assets; Chinese companies will soon be permitted to move renminbi offshore to undertake foreign investments.

Clearly, China is making significant strides and policy changes are taking place at a very rapid rate. The People's Republic is not remotely indecisive. Big challenges lie ahead, the most important of which is the containment of inflation.

While this major hurdle is being negotiated, China is very unlikely to risk a large currency revaluation.