By Leika Kihara and Andrea Shalal
NIIGATA, Japan (Reuters) -A standoff in Washington over raising the U.S. debt ceiling overshadowed a meeting of Group of Seven (G7) finance leaders starting on Thursday, heightening U.S. recession fears as central banks seek a soft landing for the global economy.
The central bank governor of host Japan said the U.S. debt crisis may be discussed at the G7 gathering, adding the group must stand ready to respond to any market repercussions.
"I have faith U.S. authorities will do their best to prevent it from happening," Kazuo Ueda told reporters on Thursday, when asked about the chance of the United States defaulting on its debt.
"The immediate fallout is something U.S. authorities would have to deal with. But (the G7 group) will likely scrutinise the situation ... and respond as needed," he said, adding that Japanese authorities were watching developments closely.
Treasury Secretary Janet Yellen was expected to face questions from her G7 counterparts, meeting in the Japanese city of Niigata, on how Washington intends to prevent turbulence in financial markets, already jittery after the recent failure of three U.S. regional banks and strains in Europe.
"A default would threaten the gains that we've worked so hard to make over the past few years in our pandemic recovery. And it would spark a global downturn that would set us back much further," Yellen said in Niigata on Thursday.
President Joe Biden has signalled the chance of cancelling his trip to next week's G7 summit if the debt standoff is not solved in time, warning that failure to quickly to raise the limit on the government's permitted borrowing from the current $31.4 trillion could throw the U.S. economy into recession.
The U.S. debt crisis is a headache for Japan, which is this year's G7 chair and the world's biggest holder of U.S. debt.
"The G7 won't be able to come up with a solution for what is a purely domestic and political U.S. problem, though the group could reaffirm its resolve to cooperate in stabilising markets in the worse-case scenario," said Takahide Kiuchi, an analyst at Nomura Research Institute.
"Washington is solely responsible to get this fixed. But when things go wrong, all the other countries bear the brunt."
GLOBAL OUTLOOK DAMPENS
The G7 finance chiefs meet at a time when aggressive U.S. and European monetary tightening begin to weigh on global growth and stoke fears of financial instability.
After the recent failure of several U.S. banks, the G7 will discuss ways to strengthen the global financial system and combat risks of digital bank runs, Japanese officials say.
Simmering U.S.-China tensions also cloud the outlook for the global economy that is already under pressure from signs of weakness in the world's second-largest economy China.
Yellen told a news conference that Washington had been considering the chance of imposing restrictions on outbound investment to China to counter its "economic coercion" against other countries.
The United States hoped to discuss the idea with its G7 allies at this week's meeting, she added.
Signs that China's post-COVID recovery may be flagging are clouding policymakers' hopes that a rebound in the country's demand would underpin global growth. China's consumer prices rose at the slowest pace in more than two years in April, while factory gate deflation deepened, data showed on Thursday,
Other key themes to be discussed at the G7 finance gathering include steps to prevent Russia from circumventing sanctions over its invasion of Ukraine, and diversifying supply chains away from China through partnerships with low- and middle-income nations.
Among other issues, Brazilian Finance Minister Fernando Haddad told reporters after a meeting with Yellen that he had expressed serious concerns that Argentina's economic challenges could usher in an extremist government. He said Argentina needed the assistance of the International Monetary Fund. The United States is the largest shareholder in the global lender.
DEBT BATTLE
Past U.S. debt ceiling fights have typically ended with a hastily arranged agreement in the final hours of negotiations, avoiding an unprecedented default.
In 2011, the scramble prompted the first downgrade of the top-notch U.S. credit rating. Veterans of that battle warn the current situation is riskier because political divides have widened.
Back then, the G7 finance leaders said in a statement that they were "committed to addressing the tensions stemming from the current challenges on our fiscal deficits, debt and growth."