Is China About to Gain Entry to the IMF’s Currency Country Club?

China has the world’s second-largest economy, but its currency, the renminbi, has been kept out of the International Monetary Fund’s elite club of the world’s strongest national tenders. That might be about to change.

According to Bloomberg, IMF officials have told Chinese leaders it’s likely the renminbi will enter the organization’s Special Drawing Rights (SDR), an international reserve fund made up of virtual currency meant to back up national coffers, by year’s end. That would put it in the same league as the euro, the Japanese yen, the U.K. pound sterling, and the U.S. dollar. IMF spokesman Raphael Anspach said no final decision had been reached but that one would be announced at a meeting scheduled in November.

The IMF has kept the renminbi out of the SDR because it historically hasn’t been “freely usable,” meaning that it wasn’t widely used to pay for international transactions or traded on international monetary exchanges. In August, the fund extended its SDR currency basket window to September 2016. The IMF said the new timeline would give countries drawing from the fund, like Ukraine, “lead time to adjust in the event that a decision were to be taken to add a new currency to the SDR basket.” But it also gives China more time for liberalization reforms. If a new currency is added, it would join the SDR in October 2016, according to the IMF’s Anspach.

China has taken full advantage. After an Aug. 4 IMF progress report determined China hadn’t implemented liberalization reforms the IMF demanded — and that Chinese President Xi Jinping had long promised — China took the hint. A week later, it allowed the renminbi to “float” for three days and let supply and demand determine its value, just like the euro, pound, and dollar do each day.

Then, on Sept. 10, China announced it would open its domestic foreign exchange market to foreign central banks, allowing the likes of the U.S. Federal Reserve and the European Central Bank to make bets on the renminbi’s value. In the past, central banks would have had to route investments in the yuan, the name of an individual unit of Chinese currency, through local banks, a costly and complicated process.

According to Nicholas Lardy, a China expert at the Peterson Institute for International Economics, this move was an imperative one. He said that central banks can now hedge their bets on other currency, like the euro or dollar, in China because they can take a position on the yuan.

“It’s quite likely that they will get in,” he told Foreign Policy in a recent interview. “They have done a tremendous amount to address the August review of the SDR basket.”

China took additional steps to liberalize last Friday, when the People’s Bank of China announced it would remove caps on deposit rates. This means financial institutions can offer Chinese savers a market-based rate of return for their money, as opposed to one determined by the Chinese central bank.

The shift in policy will “allow greater leeway for market forces to influence bank loan and deposit rates and the Chinese financial system generally,” Bill Adams, a senior international economist at PNC Financial Services Group, said in a research note.

Getting into the SDR would be even more important symbolically as a “merit badge” that shows the renminbi has the IMF’s seal of approval, as Alan Blinder, a former U.S. Federal Reserve vice chairman, said on Bloomberg television Friday. It also is an acknowledgement that Xi is increasingly allowing market forces — not government intervention — to determine China’s economic fate.

China is making these changes despite growing questions about the actual health of its economy, including whether Beijing would be able to meet its 7 percent growth target for 2015. Its benchmark stock market, the Shanghai Composite Index, was down 40 percent this summer and has only recovered slightly since. In an effort to stimulate economic growth, the Chinese central bank cut interest rates Friday, the sixth time since November of last year.

Earlier this month, IMF Managing Director Christine Lagarde warned spillover from China’s slowdown could impact the rest of the global economy. U.S. Fed chief Janet Yellen has repeatedly cited China as a reason why U.S. interest rates remain near zero.

However, in an interview with the Wall Street Journal, the IMF’s top Asia economist, Changyong Rhee, said concerns about China are overblown.

“We don’t think there’s enough evidence based on the manufacturing sector that there will be a hard landing,” Rhee said in an article published Friday. “They definitely have a manufacturing slowdown, an overcapacity problem. But other parts of China are actually growing faster.” He added that government intervention would only exacerbate Beijing’s problems.

U.S. Treasury Secretary Jack Lew and President Barack Obama have long called for China to liberalize its economy. A Treasury spokesperson had no comment on Friday’s report but pointed to a fact sheet released after Xi’s visit to the United States in September. It said the White House supports the renminbi’s inclusion in the SDR “provided the currency meets the IMF’s existing criteria in its SDR review.” U.K. Treasury director Katharine Braddick is also on board.

One SDR member — Japan — might not be as enthusiastic, according to Scott Kennedy, a China expert at the Center for Strategic and International Studies, and bruised regional egos could be the culprit. Check out the pie graphs below with data supplied by CSIS and the IMF. The first shows the current makeup of the SDR. The second shows how the renminbi would change if it was added right now, based on how the IMF calculates it.

If the renminbi is added to the SDR, it would make up for more than the British pound and the Japanese yen. If that occurs, “the Japanese would be the ones to object [to its addition],” Kennedy said, because Beijing would have a bigger stake in it than Tokyo.

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