'US-China ties probably most important economic relationship'

Lew said the challenge for China to go forward is going to be to stick with the reform agenda that has been outlined both in the Third Plenum and most recently at the National People's Congress.

"The US-China economic relationship is probably the most important economic relationship in the world. It's the two largest economies in the world," Lew told a Washington audience at a meeting held on the sidelines of the annual fall meeting of the IMF and the World Bank yesterday.

"I think that the desire to be included in the Special Drawing Rights (SDR) basket at the IMF was a very helpful incentive for China to make reforms in how it manages currency, how it manages its economy and I think it's important for China to have made those changes," he said.

Lew, however, cautioned against over-reading of immediate impact of being in the SDR basket.

"It is not the equivalent of becoming immediately a global reserve currency. Nor does it reflect a completion of a reform agenda. It's an important step along the way, it's a recognition that China has made important policy changes and that they meet the standards of the IMF," Lew said.

He said it is important to reform the economy so that market forces play a much more dominant influence to deal with the problem of excess capacity so that China does not end up choking on things that there is not a market for.

Lew also said the US and China had engaged in fierce debates about exchange rate policies for a decade.

"China has changed how it's managing its exchange rate, so that that's less of a hot issue today than it was five years ago. That's a good thing," he said, adding that this does not mean that the US has taken its "eye off the ball".

"We are going to continue to watch. The real test is gonna be when there's pressure for the RMB to appreciate - does China let it appreciate? They've certainly said all the right things. But, you know, the jury will be out until we see the macro-economic circumstances that test that," Lew said.

It cannot be a good thing if excess capacity becomes the exchange rate issue of the next decade. It would not be good for China, it would not be good for US-China relations, it would not be good for the global economy, Lew said.

He said the question of excess capacity is deeply troubling around the world wherever steel and aluminium are made.

"Fundamentally, it's just not good for China, because China is not going to end up having the economic strength that it needs. I believe there's still room for China to manage what is the hardest transition from a heavily industrial to a much more consumer driven economy in the second largest economy in the world," he said.

"They have space. But it's not infinite space. Sticking to the programme, implementing it even though it's disruptive and it is something that may be unpopular in parts of the country, is essential," Lew said.