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UPDATE 1-IMF says dollar overvalued; euro, yen, yuan broadly in line with fundamentals

fundamentals@ (Adds details on pound, won, Mexican peso)

WASHINGTON, July 28 (Reuters) - The International Monetary Fund on Friday said that the U.S. dollar was overvalued by 10 percent to 20 percent, based on U.S. near-term economic fundamentals, while it viewed valuations of the euro, Japan's yen, and China's yuan as broadly in line with fundamentals.

The IMF's External Sector Report - an annual assessment of currencies and external surpluses and deficits of major economies - showed that external current account deficits were becoming more concentrated in certain advanced economies such as the United States and Britain, while surpluses remained persistent in China and Germany.

While the report assessed the euro's valuation as appropriate for the eurozone as a whole, it said the euro's real effective exchange rate was 10-20 percent too low for Germany's fundamentals, given its high current account surplus.

Britain's pound, meanwhile, was assessed as up to 15 percent overvalued compared to fundamentals, which include a high level of uncertainty over Britain's post-Brexit trading relationship with the European Union.

The Fund said the dollar's appreciation in recent years was based on its relatively stronger growth outlook, interest rate hikes versus looser monetary policy in the eurozone and Japan, as well as expectations for fiscal stimulus from President Donald Trump's administration.

But so far this year, the dollar index, the broad measure of its value against other major currencies, is down more than 8 percent this year and is off to the worst start to a year since 2002.

The IMF recommended that U.S. authorities take steps to shrink a current account deficit that remains too large, by reducing its federal budget deficit and passing structural reforms to increase the savings rate and improve the economy's productivity.

"It's important to address imbalances, because if they're not dealt with appropriately and through the right policies, we could have a backlash in the form of protectionism," IMF Research Division Chief Luis Cubeddu told a news conference.

Cubeddu said that the persistence of current account surpluses in export countries such as China and the growth of deficits in debtor countries such as the United States suggested that the problem would not clear up automatically.

"That is, prices, savings and investment decisions don't seem to be adjusting fast enough to correct imbalances. This partly reflects rigid currency arrangements, but also certain structural features, like inadequate safety nets, barriers to investment, which leads to undesirable levels of savings and investment," he said.

The report said that while China's yuan was broadly in line with its fundamentals, IMF models showed wide divergences with desired policies from a 10 percent overvaluation to a 10 percent undervaluation due to uncertainties over Beijing's policy outlook.

The U.S. Treasury in April refrained from declaring China a currency manipulator despite Trump's campaign promises to do so, citing Beijing's interventions last year to prop up the yuan's value in the face of capital outflows. But it kept China, South Korea, Taiwan, Germany and Switzerland on a monitoring list for large external surpluses. 1/2nL1N1HM0QA 3/8

The IMF said China's current account surplus was growing again after declining in 2015 and 2016 and needed to be reduced. This should be achieved by rebalancing the economy away from investment and credit growth towards more consumption, with a stronger safety net, reforms to state-owned enterprises and opening Chinese markets to foreign competition.

The report also showed that the IMF considers Mexico's peso and South Korea's won both to be undervalued by 5-15 percent compared to their fundamentals. The Fund said it expects Mexico's undervaluation to reverse as risks of protectionist U.S. policies dissipate, but South Korea needed to stimulate domestic demand to reduce a large current account surplus. (Reporting by David Lawder; Editing by Nick Zieminski, Bernard Orr)