April 17 (Bloomberg) -- The European Union broadened the threat of trade protection against China by opening Europe’s first probe into alleged subsidies to Chinese industry, highlighting concerns that the yuan is undervalued.

The EU inquiry into whether the Chinese government gives trade-distorting aid to domestic paper makers comes on top of an investigation into whether the manufacturers sell in Europe at below cost, a practice known as dumping. The two cases, which cover coated fine paper used for books and brochures, may result in EU tariffs to help producers in Europe including Sappi Ltd. compete against lower-cost imports.

The U.S. imposed duties on Chinese coated paper in 2007 to counter subsidies and dumping, prompting China to file its first solo complaint against the American government at the World Trade Organization the same year. The EU has imposed anti- dumping duties on dozens of Chinese goods from textiles and chemicals to ironing boards and bicycles while stopping short of ever threatening to apply levies to counter government aid.

“This is the EU’s first-ever anti-subsidy investigation against China,” John Clancy, trade spokesman at the European Commission, the 27-nation bloc’s executive arm in Brussels, said today by telephone. The Chinese government said it is “deeply dissatisfied” with the probe and the step “sends a wrong signal to the world and is protectionist.”

Yuan’s Peg

To bolster western exporters and curb their trade deficits, the U.S. and the EU have been pressing China to let its currency strengthen as the global economy recovers from the financial crisis. Speculation that Chinese officials may scrap the yuan’s peg to the dollar intensified this month after U.S. Treasury Secretary Timothy F. Geithner delayed a report that could brand the Asian nation a currency manipulator and made an unscheduled visit to Beijing.

China has come to a “consensus” on adjusting its exchange rate gradually and wants to avoid the impression of bowing to U.S. pressure by allowing appreciation, central bank adviser Li Daokui said in an interview with the state-run Central Television broadcast on April 15.

The EU subsidy inquiry stems from a March 4 complaint by the European Association of Fine Paper Manufacturers on behalf of producers that account for more than 25 percent of the EU’s output of coated fine paper, said the commission, which didn’t identify any companies. That industry group filed a dumping complaint covering the same product in January, prompting the commission to open an initial trade probe the following month.

EU Producers

South Africa-based Sappi makes coated fine paper in EU countries including Germany and the Netherlands. Other EU producers include Stora Enso Oyj and UPM-Kymmene Oyj.

The probe will determine whether coated fine paper from China “is being subsidized and whether this subsidization has caused injury” to European manufacturers, the commission said in the Official Journal.

China will “closely monitor” developments in the investigation according to WTO rules and reserves the right to take further action, the country’s Ministry of Commerce said in a statement posted on its Web site today.

Under EU practices, the commission can impose provisional anti-subsidy duties for four months and provisional anti-dumping levies for six months. The EU’s national governments -- acting on a commission proposal -- can turn those measures into “definitive” five-year duties at the same or different rates.

The commission has nine months from the start of an investigation to decide on provisional measures. EU governments have 13 months from the beginning of a probe to impose five-year anti-subsidy -- or “countervailing” -- duties and 15 months to impose definitive anti-dumping measures.