Government stimulus has helped China pull through the global crisis
The yuan needs to appreciate to reduce China's dependence on exports for growth, says the Organisation for Economic Co-operation and Development.
The OECD argues that more exchange rate flexibility and targeting inflation would help economic stability in China.
Its report also said the Chinese economy was weathering the global crisis "remarkably well".
It grew by 8.7% in 2009, setting it on course to become the world's second-largest, leaving Japan in third place.
Whilst the US is still the biggest economy, the OECD estimates China may well overtake it in the next five to seven years as the world's leading producer of manufactured goods.
Any move by Beijing to allow the yuan to rise in value would be welcomed by the US, which has long claimed that China keeps its currency artificially undervalued, thus giving Chinese exports an unfair advantage.
Beijing has long said that it will not allow the yuan to trade freely until its domestic economy is strong enough to pick up any resulting decline in exports.
Bad loan fears
The OECD also argues that in the wake of the global financial crisis, China should increase public spending to support reforms in education, welfare assistance, pensions and health.
However, it warns that the boom in new lending since early 2009 raises the risk of a surge in bad loans in years ahead.
The Chinese central bank has been trying to curb bank lending. Last month, it ordered the commercial banks to keep more funds in reserve for the first time since June 2008.
China is not a member of the Paris-based OECD, whose 30 constituents are some of the world's wealthiest and most developed states, but it is one of five enhanced engagement countries that the organisation work with.
The OECD's last in-depth survey of China was done in 2005.