SINGAPORE, Oct 8 (Reuters) The dollar is undervalued and the global credit squeeze is a ''serious crisis'' that will curtail growth worldwide, the head of the International Monetary Fund was quoted as saying on Monday.
''Right now the dollar is undervalued'' on many measures used by the IMF to evaluate currencies, Rodrigo Rato said in an interview with the Financial Times, adding the currency was ''certainly overvalued a few years ago''.
His remarks follow a sharp decline in the dollar against the euro and some other freely floating currencies in the aftermath of the credit squeeze triggered by the US subprime mortgage sector and the Federal Reserve's interest rate cut.
The dollar index, a gauge of the currency's value against a basket of six major currencies, fell to a record low last week. It also dropped last week to a record low against the euro.
Rato - who hands over the leadership of the IMF to Dominique Strauss-Kahn at the end of this month - said recent financial and economic developments created a ''new scenario for global imbalances'' that policy makers needed to ''keep an eye on''.
The IMF managing director regards concern over the dollar-euro exchange rate as only part of a more complex global story, the newspaper said. This also involves currencies such as China's yuan, also known as the renminbi, that are formally or informally tied to the dollar and therefore fall when it falls.
He said that ''independent of the value of the dollar'', it would be ''in the interest of China'' to adopt a more flexible exchange rate to help it manage its domestic economy and that this case is ''becoming stronger''.
More currency flexibility from China would also help its neighbours, he said.
Many emerging economies, particularly in Asia, were afraid to allow their currencies to appreciate against the dollar for fear of losing competitive advantage to China.
Rato also hinted at unease about Japan's yen, which remains weak in part because of ultra-low interest rates. The Bank of Japan's key rate stands at 0.5 per cent.
''Normalisation of monetary policy in Japan is an important medium-term objective,'' Rato said.
He said it was a fact that hedge funds had generally come through the crisis well so far and that incidents of hedge fund distress had not caused systemic strains.
But this should not preclude further consideration of hedge funds by international policy makers.
The credit squeeze had created downside risks for growth around the world, but Rato said inflation risks remained, noting that commodity prices were high and there was little spare capacity in the world economy.
Rato said it would take ''a few months; probably into next year'' before liquidity, availability of credit and risk spreads would return to more normal levels.
REUTERS TB AS0745