U.S. urges EU, IMF to be flexible with Greece

By David Milliken and Jemima Kelly

LONDON (Reuters) - The United States urged international creditors to show more flexibility in negotiations with Greece's cash-strapped government to avert a possible Greek default and exit from the euro zone with incalculable consequences.

U.S. Treasury Secretary Jack Lew issued the warning on Wednesday in a stopover in London on his way to a meeting of Group of Seven finance ministers in Dresden, Germany.

"My concern is not the goodwill of the parties -- I don't think anyone wants this to blow up -- but ... a miscalculation could lead to a crisis that would be potentially very damaging," Lew told students at the London School of Economics.

"The challenge for the Europeans, the political and economic institutions -- the IMF -- is to show enough flexibility," he said.

Washington is the dominant shareholder in the global lender and also sees strong geopolitical grounds for keeping Greece firmly anchored to the European Union.

Finance ministers from the United States, Japan, Germany, France, Italy, Britain and Canada are meeting in Dresden on Thursday and Friday, and although Greece is not formally on the agenda, it will be discussed on the sidelines.

Greece's government has said it does not have enough money to repay loans from the International Monetary Fund without further help from Europe.

Markets rallied strongly on Wednesday after Athens issued a statement attributed to a Greek official saying negotiators had begun drafting a staff-level agreement on a cash-for-reform deal. However EU officials dismissed the report and said the sides were still far apart on key issues.

A senior EU source said behind the scenes, the United States was leaning heavily on the IMF and on Germany to be more conciliatory towards Greece to permit a deal, if Greek Prime Minister Alexis Tsipras also makes a significant move.

But further support for Greece is unpopular with the public in many euro zone countries such as Germany, especially as the current Greek government has reversed previous reforms.

While most Greek debt is now owned by public institutions rather than commercial banks -- reducing the risk of a bank run in case of default -- Lew warned against complacency.

"The notion that the risk is completely contained, that there's no contagion -- I think that it's a mistake to think that a failure is of no consequence outside of Greece. We don't know the exact scope," he said.

Greece itself needed to pursue reforms which any government would find hard, Lew added.

Lew's office said he spoke earlier on Wednesday with Tsipras and urged him to find common ground with EU and IMF negotiators.

YUAN FLEXIBILITY

Lew was cautious about an IMF announcement on Tuesday that the yuan <CNY=CFXS> was no longer undervalued. The United States has long complained that China gives its exporters an unfair advantage by not allowing the yuan to strengthen freely.

Lew said it was too early to say if China had permanently changed its ways, and that the IMF may be unable to reach a decision this year and add the yuan to the basket of currencies like the dollar that form its internal currency, the SDR.

"The standard has to be what will they do when there's pressure on the (yuan). For competitive purposes, will they continue to refrain from intervention. And ... are they truly committed to having a market-determined exchange rate?"

Addressing the U.S. economy, Lew said weak growth in the first three months of the year had been an anomaly, and that he expected the second half to be stronger.

Asked about the prospect of the Federal Reserve raising interest rates, he said central banks needed to communicate their intentions clearly.

Bond markets have been volatile in recent weeks as well as last year, which traders partly attribute to uncertainty about when the United States will start to raise interest rates.

(Additional reporting by Andy Bruce in London and Paul Taylor in Brussels.; Editing by Paul Taylor/Mike Peacock.)