China will chart its own course in reforming the yuan, President Hu Jintao told President Barack Obama, reinforcing the view that Beijing is likely to tip-toe, not leap, toward appreciation.

The two heads of state, meeting on Monday for the first time since Sino-U.S. tensions over the yuan threatened to escalate into a serious trade dispute, chose their words carefully and, in the view of investors, left the door open for Beijing to resume appreciation in the coming weeks.

Hu said China would not be pushed by external pressure and would instead base any decision on the yuan on its own economic needs. But he also made clear that Beijing was committed to change.

China will firmly stick to a path of reforming the yuan's exchange rate formation mechanism, Hu told Obama, according to the official Xinhua news agency account of their discussion on the sidelines of a nuclear security summit in Washington.

In making reforms, we will give careful consideration to global economic developments and changes, as well as to China's economic condition, Hu said.

The yuan edged down in the offshore forwards market on Hu's comments and Asian currencies, which have gained in recent weeks on expectations of a Chinese revaluation, also dipped. The Malaysian ringgit, often used as a proxy for the yuan, dropped 0.8 percent.

Investors were, however, still positioning themselves for a gradual resumption of yuan appreciation.

Beijing has frozen the yuan's exchange rate against the dollar since mid-2008 to help cushion its economy from the global downturn, but the strength of China's recovery has fueled criticism of this policy and market expectations that it is about to resume appreciation.

Notable by its absence in Hu's reported comments was a declaration, previously a stock phrase for Chinese leaders, that a stable yuan was benefiting the global economy.

Obama, for his part, touched only delicately on the yuan, with his focus on the summit at hand and the goal of winning Chinese support for tougher sanctions against Iran's nuclear activities.

The president reaffirmed his view that it is important for a ... sustained and balanced global economic recovery that China move toward a more market-oriented exchange rate, Jeffrey Bader, a top White House adviser, told reporters.

HEAVY EXPECTATIONS

The U.S. Treasury this month delayed publication of a report that politicians had urged Obama to name China a currency manipulator, potentially paving the way for punitive trade measures. China had warned repeatedly that foreign criticism of its currency policy would be counter-productive.

Months of tensions -- over trade, Internet freedom, Taiwan and Tibet -- placed heavy expectations on the 90-minute talks on the sidelines of Obama's nuclear security summit, even if the meeting was unlikely to produce concrete results.

Most importantly, it seems that the atmospherics surrounding the bilateral U.S.-China relationship have improved, opening the door for movement on a number of issues, said China expert Drew Thompson of the Nixon Center in Washington.

Three-month dollar/yuan non-deliverable forwards rose to 6.7610 from Monday's close of 6.7500, pricing in 0.96 percent appreciation within three months versus 1.12 percent.

The trend for China to abolish the yuan/dollar peg this year remains intact, with the earliest move possibly coming late this month or in May, said a senior dealer at a major Chinese bank in Shanghai.

The yuan last week hit six-month highs against the dollar in the spot market and twenty-month highs in the forwards market after the New York Times reported that China was poised to announce an imminent revaluation.

NO PANACEA

With China's exchange rate policy under intense scrutiny, Hu also used the meeting with Obama to press its argument that a stronger yuan would not be a panacea for woes afflicting the world's largest economy.

Yuan appreciation would neither balance Sino-U.S. trade, nor solve the unemployment problem in the United States, Hu said.

He added that China wants to increase its purchases of U.S. goods, urging Washington to ease export controls on high-tech products.

U.S. politicians complain the value of the yuan is being held down against the dollar by Beijing to boost Chinese exports at the expense of U.S. exports, and thus jobs, and want Obama to take a hard line to push China to allow appreciation.

The U.S. trade gap with China narrowed to $226.8 billion in 2009 from a record $268.0 billion in 2008.

Jong-Wha Lee, Asian Development Bank chief economist, told a news conference that it was very important to align China's

currency with its fundamentals. There is no doubt that a stronger yuan will help reduce global imbalances, he said.

Recent signals from Beijing encouraged hopes that it was edging toward a more flexible yuan, which analysts say would suit China's own interests as its economy takes off, with exports recovering strongly and inflation picking up.

(Additional reporting by James Pomfret in Hong Kong and Caren Bohan in Washington; Editing by Ken Wills and Ron Popeski)

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