(Adds details from euro zone document)
By Jan Strupczewski
IQALUIT, Canada, Feb 4 (Reuters) - The United States and China will have to lead a rebalancing of global growth as the world economy slowly emerges from a downturn, the euro zone will tell G7 financial leaders this weekend according to a document prepared for the meeting.
Finance ministers and central bank governors from the Group of Seven (G7) industrialised nations meet Friday and Saturday in the small town of Iqaluit in north Canada. The G7 includes the U.S., Canada, Japan, France, Germany, Britain and Italy.
The document, which sums up the agreed views of the 16 countries using the euro, said global trade and savings imbalances, which deepened the global economic downturn, have decreased during the crisis, but were still a medium-term challenge and need to be unwound in an orderly way.
"Looking further ahead imbalances will widen again -- driven by the recovery of oil prices and global trade -- although at a lower level compared to the period before the crisis, with the exception of China where the current account surplus will continue to increase in dollar terms," the document said.
"The United States and China will have to take a central role in the rebalancing of global growth," said the document, which was obtained by Reuters.
To achieve this, the United States should boost domestic savings, cut its budget gap and improve financial regulation.
"Beyond the current short-term counter-cyclical requirements, fiscal consolidation should remain the main objective," the document said.
Unless U.S. fiscal and monetary stimuli are withdrawn once economic recovery is well established, it said, expansionary policies could sow the seeds of instability, including the building up of bubbles.
China needs to boost domestic consumption by improving its social safety nets.
"A reformed taxation of state-owned enterprises' profits would increase tax revenues, which could, in turn, be used to finance increased state spending on social safety nets without jeopardising longer-term fiscal sustainability," it said.
China should also allow its yuan currency, now effectively pegged to the dollar, to appreciate, the document said.
"Its current exchange rate policies may induce a return to large global imbalances and may drive up asset prices which could jeopardise China's financial stability."
Beijing could start rebalancing its growth model next year, it said.
"The 12th five-year plan starting in 2011 should aim at laying the foundations of a different Chinese growth model, which relies less on export-led growth and more on private consumption."
EXIT STRATEGIES
The document said G7 countries should coordinate and clearly communicate in advance their plans to withdraw fiscal stimulus to help control inflation, among other things.
"Increasing budget deficits and public debt could weigh on the economies going forward. Clearly communicated medium- to longer-term policy frameworks are an essential component for stabilising expectations," it said.
It said inflation in the euro zone, which the European Central Bank wants to keep below, but close to, 2 percent over the medium term, was likely to rise moderately near term.
"The outlook further out is for relatively subdued inflation rates, as the sizeable slack in the product and labour markets can be expected to restrain inflation."
The world economy was improving but that was partly due to government support. "Looking forward, moderate optimism is warranted on the back of recent macro-economic indicators and normalising financial markets," it said.
"Overall, available leading indicators suggest a modest resumption of growth in the coming months, while Asian continues to show dynamism," it said.
But it cautioned the recovery could run out of steam if private demand did not kick in once fiscal stimulus is gone.
"This is particularly worrying given that unemployment is expected to stay high in the short term, precautionary saving has increased, private sector deleveraging continues and also given the negative wealth effects as a result of the crisis," it said.
"The pace of recovery is expected to be gradual and growth subdued, while risks remain given the high unemployment rates and the recent increase in commodity prices," it said.
FX VOLATILITY A THREAT TO RECOVERY
Volatile markets were another threat to stable growth.
"Market volatility, in particular in the foreign exchange market, as well as the possible build up of new asset bubbles, could destabilise the nascent global recovery by placing growth on an unbalanced path and trigger unwelcome protectionist reactions," the document said.
In remarks to Japan, the euro zone document said medium-term fiscal consolidation was a key challenge.
"As the risk of a protracted recession dissipates, ambitious fiscal consolidation should be considered," it said.
It also said that over the medium term, higher Japanese interest rates would help correct current account imbalances and anchoring inflation expectations.