WRAPUP 3-U.S., China face off over currency ahead of G20

* China says exchange rate management a sovereign issue

* Obama says market-determined exchange rates "essential"

* Canada calls for halving fiscal deficits

* Some common ground on medium-term fiscal fix

(Adds quotes, analyst, Canada prime minister, White House)

By Jeff Mason and Simon Rabinovitch

WASHINGTON/BEIJING, June 18 (Reuters) - The United States pressed China on Friday to move toward a market-based exchange rate, but Beijing said not to meddle with its management of the yuan, setting the stage for a clash at next week's G20 summit.

World leaders gathering in Toronto on June 26-27 are struggling to maintain the crisis-forged unity that has been credited with preventing another Great Depression.

Now that the global economy is on the mend, divisions are beginning to show.

U.S. President Barack Obama released a letter to his Group of 20 colleagues that zeroed in on prickly policy differences over China's currency stance and debt-wary Europe's rush to rein in bulging budget deficits. [ID:nLDE65H1GB]

Canadian Prime Minister Stephen Harper, who will host the meeting, urged G20 countries to halve their fiscal deficits by 2013 and stabilize debt-to-GDP ratios by 2016, according to an official, who also said China's currency would be discussed. [ID:nN18161587]

But China largely took the issue off the table, saying its currency, also known as the renminbi, was its own business. [ID:nTOE65H02J]

"The RMB is China's currency, so I don't think it is an issue that should be discussed internationally," Cui Tiankai, a vice foreign minister who is China's G20 sherpa, the official in charge of preparing for the summit, told a news briefing.

Obama, under pressure from some U.S. lawmakers who accuse his administration of soft-pedaling on China, said free-floating currencies were "essential" to global economic activity, a thinly veiled reference to the yuan.

"The signals that flexible exchange rates send are necessary to support a strong and balanced global economy," Obama wrote.

China has kept the yuan steady at around 6.83 per dollar for almost two years to help its exporters ride out the global financial crisis. Many Western economists believe it is undervalued by as much as 40 percent.

"China's statement is ... absolutely outrageous," said Morris Goldstein, a senior fellow at the Peterson Institute for International Economics in Washington "Where should we be discussing it. At the World Cup?"

Obama's administration has stopped short of accusing China of manipulating its currency to give it a trade advantage, something that some members of the U.S. Congress have urged.

The Treasury Department delayed its regular currency report to Congress, which was due in April, angering some legislators who think the administration is dragging its feet.

The White House said the world would be "better off" if China had a market-based exchange rate. A spokeswoman said the administration would "take stock" on the issue of the currency report after the G20 meeting.

The yuan rose to a one-month high against the dollar in offshore forwards on Friday as investors bet that China might eventually cave in to growing pressure to let the yuan rise in value. ((For the yuan market report, click on: [CNY/]))

DON'T PULL THE PLUG NOW

Obama also directed stern words at Europe. In a letter to G20 colleagues dated June 16, he said the highest priority at next week's meeting must be to safeguard the recovery and not succumb too soon to demands to shrink government debt.

"We worked exceptionally hard to restore growth; we cannot let it falter or lose strength now," he said.

The United States has urged Germany in particular not to pull the plug on government spending too soon for fear that doing so will derail the still-fragile economic recovery.

Berlin thinks shoring up public finances is an immediate priority, underscored by Greece's debt troubles and growing worries that other small, heavily indebted European countries could face a similar fate.

Obama said it was critical that the timing and pace of the fiscal pullback "suit the needs of the global economy" and not just domestic demands.

The United States and China appeared to find some common ground on this issue. Zhu Guangyao, China's vice finance minister, said countries with serious budget deficits should accelerate fiscal consolidation but in a manner that is "growth-friendly."

U.S. Treasury Secretary Timothy Geithner has used the same phrase to describe the U.S. position on debt.

Obama said countries should be prepared to respond quickly and forcefully to avert another slowdown if the recovery fades. That might not be well received at home, where Obama has faced resistance from Congress over adding to an already swollen government debt burden.

Former Federal Reserve Chairman Alan Greenspan urged the United States to concentrate on boosting its public finances, too. [ID:nSGE65H09F]

"An urgency to rein in budget deficits seems to be gaining some traction among American lawmakers. If so, it is none too soon. Perceptions of a large U.S. borrowing capacity are misleading," he wrote in The Wall Street Journal.

"Our economy cannot afford a major mistake in underestimating the corrosive momentum of this fiscal crisis. Our policy focus must therefore err significantly on the side of restraint." (Additional reporting by Emily Kaiser, Alister Bull and David Ljunggren; editing by Chris Wilson)