BEIJING (Reuters) - The International Monetary Fund said the Chinese yuan was only "moderately undervalued" against a basket of currencies in an annual assessment released on Wednesday, suggesting a lessening of international pressure on Beijing over its foreign exchange and trade policies.
The IMF's new stance on the yuan's value - it had previously called it "substantially undervalued" against the dollar - comes as the currency approaches what many regard as fair value, and as the issue recedes as a point of diplomatic friction between the West and China.
The report said economic reforms so far had substantially reduced external imbalances, but at the cost of significant domestic imbalances fueled by China's investment-driven growth model. It warned of risks to growth if investment were to slow sharply or if there were a sudden rise in non-performing loans.
The new language on the currency reflects a growing international consensus that the yuan is closing in on its fair value after about a decade at an artificially weak level, potentially reducing it as a political and international trade issue.
"Now, with the IMF saying it is OK, the legitimacy of the accusation (that China distorts the value of its currency) has been lost," said Tu Xinquan, associate director of the China Institute of WTO Studies at the University of International Business and Economics in Beijing.
"Some U.S. politicians will still talk about this issue because the bilateral trade deficit is still there. But I think the U.S. government will not focus on this issue."
Nonetheless, the IMF's view is that the exchange rate still has a "non-trivial" way to appreciate, Markus Rodlauer, the deputy director of the IMF's Asia-Pacific department, told reporters on Wednesday. He did not give an exact value.
Last year's report said the yuan was "substantially undervalued" against the dollar by between 3 percent and 23 percent, depending on the methodology used.
The IMF also lowered its medium-term forecast for the current account surplus to between 4 percent and 4.5 percent of GDP. That level is roughly consistent with what economists consider to be a fairly-valued currency, and in line with levels that U.S. Treasury Secretary Timothy Geithner has previously said would help keep the global economy well-balanced.
Chinese contributors to the report rejected sharply the idea that the yuan is not yet fairly valued.
"This assessment, in my authorities' view, is not consistent with the reality," IMF executive director Tao Zhang said in the Chinese authorities' official response, included in the report.
"The sharp decline in the current account surplus and the recent two-way movements in the renminbi suggest that the currency is roughly in equilibrium."
China's big trade and current account surpluses of past years had fuelled trade tensions with other countries, particularly the United States.
The U.S. Treasury has refrained from labelling China a "currency manipulator" to avoid antagonizing the emerging giant and possibly stalling further reforms.
"I feel the pressure from the U.S. is certainly not as big as a few years ago, even though it's an election year," said Zhiwei Zhang, China chief economist at Nomura.
He added that Beijing had moved faster than the market expected recently in allowing more flexible trading.
"All this shows the currency is near equilibrium."
While Congress threatened punitive action if the yuan did not move, multinational businesses operating in China complained that restrictive industrial policies caused them more problems but lacked the same punch as a political slogan.
"The exchange rate issue is just one part of a package of reforms needed to rebalance the economy," Rodlauer said.
Without those reforms, "it will be very likely that the current account surplus will go up again, not to where it was before but more than it was now," he added.
"Gradual appreciation will be necessary in upcoming years."
The IMF report warned of a number of risks to China's economy, specifically the question of whether banks or local governments would bear the burden of non-performing loans - many stemming from China's massive 2008 stimulus package - if the economy were to slow sharply.
Other recommended reforms included better pricing signals following on China's moves to give banks more flexibility in setting interest rates, more financial investment options to avert another speculative leap into real estate and tax changes to support a shift from investment-led to consumer-led growth.
The mid-point against which the Chinese yuan may trade was set at 6.3429 against the dollar on Wednesday, its weakest point since December 2011, and fell to a fresh 10-month low in spot trade.
The yuan has fluctuated against the dollar this year, reversing many years of one-way appreciation.
Traders interpreted Wednesday's move as a signal from Beijing that it was prepared to accept further depreciation to help exporters cope with the global economic slowdown. The yuan has now fallen 1.5 percent against the dollar so far this year, while gaining 0.6 percent against the euro.
China doubled the permitted trading band for the yuan in April, saying the currency could rise or fall 1 percent from the mid point.
The IMF, which last week cut its forecast for China's 2012 growth to 8 percent from its April assessment of 8.25 percent, reiterated that the biggest external risk the country faced was a worsening of the euro zone debt crisis.
The IMF's view is above the government's target of 7.5 percent and in line with the consensus forecast in the latest Reuters poll.
Additional reporting by Michael Martina in Beijing and Lesley Wroughton in Washington; Editing by Neil Fullick & Kim Coghill