After a day of top-level talks with Chinese leaders including President Hu Jintao, Mr Paulson said he felt China lacks adequate capital markets to have a fully market-based currency but that remains the ultimate objective.

'I acknowledged to President Hu the very material progress that they've made with their currency because they have a currency that more accurately reflects underlying economic fundamentals,' Mr Paulson said, adding that gives China 'a very important tool' in its bid to keep food price rises in check.

Mr Paulson is scheduled to deliver a speech on energy issues on Thursday and to hold more meetings with senior officials including Premier Wen Jiabao, who has expressed his worry about the potential global impact of a steep US economic downturn.

Mr Paulson said he told the officials he met on Wednesday that the United States was in 'a sharp slowdown', adding 'It's a very difficult corner we're in right now'.

In a later interview on Bloomberg television, he took issue with an International Monetary Fund report slashing its 2008 US economic growth forecast to 0.5 per cent from 1.5 per cent previously and saying the US economy was expected to tip into recession.

Overblown
'That sounds a little overblown to me,' Mr Paulson said, though he acknowledged that he told Chinese officials 'risks are to the downside' for US economic performance currently.

A key reason for Mr Paulson's visit was to meet newly promoted Vice-Premier Wang Qishan, who is taking charge of the US-China 'Strategic Economic Dialogue' (SED) that the Treasury chief was instrumental in launching in 2006.

Mr Paulson said he has known Mr Wang, a former mayor of Beijing, for years and worked with him when he headed Wall Street investment bank Goldman Sachs. Mr Wang endorsed the SED process and said he felt it was not only useful commercially but as a means to keep China-US relations on a smooth track.

The next SED session is scheduled for June in Washington.

Mr Paulson indicated he expects another SED meeting at the end of the year, after November's presidential elections, but declined to predict its future after that.

'At the end of the day, the next administration will evaluate the SED,' he said. 'The Chinese understand that and we understand that.'

Poor example
Mr Paulson conceded the current turmoil in US markets, stemming from a subprime mortgage meltdown that triggered a credit crunch and forced Treasury to propose a sweeping overhaul of widely-blamed lax regulations, doesn't set a good example.

'There's no doubt that what is happening in US markets clearly has to give the Chinese pause,' Mr Paulson said, adding that it was important to learn from experience and keep persuading China to make needed market reforms.

'They've headed down the path to a market economy and capital markets are a very powerful force for good,' Mr Paulson said.

'The key is that, as they open up and they're the ones that create the regulatory structure, that the same rules will apply to all financial institutions.'

Mr Paulson is an advocate of diplomacy to persuade China to allow US financial firms more access to its markets and to persuade Beijing that it is in its own interest to let the yuan rise more swiftly. Many US lawmakers say Paulson's efforts are not producing results fast enough.

But the Chinese central bank has in fact let the yuan climb much more quickly in recent months.

The currency gained 4 per cent against the dollar in the first quarter, compared with 6.86 per cent in all of 2007, as China used a stronger exchange rate as one of the tools to fight inflation, which is at a near 12-year high of 8.7 per cent.

However, Tao Wang, head of Greater China economics with Bank of America in Beijing, said she did not expect this pace to last.

'Once the current inflation pressure abates and weak export numbers become obvious, the yuan/dollar adjustment is expected to slow,' she said in a report released on Wednesday.

The US Treasury chief also confirmed that he had expressed the Bush administration's concern about China's handling of protesters in Tibet but refused to say whether he had done so in his meeting with Mr Hu. -- REUTERS