July 3 (Bloomberg) -- The International Monetary Fund is softening the language used to characterize exchange rates ahead of the lender’s first report in three years on China’s economy.

The 186-nation fund won’t use the phrase “fundamental misalignment” in describing currencies, and spokeswoman Caroline Atkinson told reporters yesterday that the new policy will promote better cooperation with member states. The IMF’s board next week is scheduled to discuss its assessment of China, known as Article IV consultations, and then issue recommendations for the first time since 2006.

While Managing Director Dominique Strauss-Kahn has called China’s yuan “substantially undervalued,” the IMF has stopped short of criticizing it as disconnected from economic fundamentals. The softer rhetoric removes a sticking point between China and the IMF, as Asia’s second-largest economy seeks a larger role at the lender and the fund tries to increase China’s contributions.

“There’s nothing constructive to be had from using stronger language on the Chinese currency,” said Glenn Maguire, chief Asia-Pacific economist at Societe Generale SA in Hong Kong. “When you’re looking at having a more constructive working relationship with a country you tend not to be as critical of it. The U.S., China and the IMF have bigger issues to deal with right now.”

Draft Report

A draft of the IMF’s Article IV report on China uses Strauss-Kahn’s description of the yuan as “substantially undervalued,” according to a person who has seen the document. The report avoids using stronger language to describe the yuan, said the person, who requested anonymity because it isn’t scheduled to be published until next week.

Yoshiko Kamata, an IMF spokeswoman in Washington, declined to comment, citing IMF policy against speaking about unpublished internal documents.

The case for calling China’s currency fundamentally misaligned weakened this year because the nation’s accumulation of foreign-exchange reserves slowed, the person said.

China’s reserves, the world’s biggest, had their smallest gain in eight years in the first quarter as exports slumped and weaker economic growth deterred investment from abroad. The holdings increased about $7.7 billion to $1.9537 trillion, compared with a rise of about $154 billion a year earlier.

The IMF staff mission to China ended on June 10 and the executive board is scheduled to discuss the staff’s findings on July 8, said Atkinson, head of external affairs at the fund.

‘Candid’ Discussions

“The guidance to the staff is not going to constrain whatever the executive board decides to do,” Atkinson said at a briefing in Washington. The new guidelines “will support more candid and open discussions of policies, both with staff and countries and in the executive board,” she said.

She said the new language for staff reports describing exchange rates took effect on June 23. An executive-board level report on China has been delayed since 2006 as the two sides disagreed over wording.

A harsher judgment by the IMF may have prompted some U.S. lawmakers to increase pressure on Treasury to describe the nation as a “currency manipulator.” Treasury Secretary Timothy Geithner has refrained from using that phrase since January when he made the assertion in written testimony to Congress, prompting denials from Chinese officials.

The Treasury said in a report released in April that while the yuan remains “undervalued,” no country “met the standards” for illegal currency manipulation in the second half of 2008.

‘Reasonable’ Level

China’s foreign ministry officials have this year reiterated that the government will push forward the reform of the exchange-rate mechanism to maintain the yuan’s value at a “reasonable” rate.

The dialogue between the U.S. and China has also been marked this year by Chinese concern at the value of the dollar. Central bank Governor Zhou Xiaochuan called in March for the creation of a “super-sovereign” currency, after Premier Wen Jiabao voiced concern that a weakening dollar would erode the value of the nation’s U.S. assets.

“We hope that as the main reserve currency the exchange rate of the U.S. dollar will be stable,” Vice Foreign Minister He Yafei told reporters in Beijing yesterday. The official said he’s “not aware” of China pushing to put the subject on the G- 8 agenda.

China has held the yuan level against the dollar since July last year, helping the nation’s exporters, after a 21 percent gain in the previous three years. The currency closed little changed yesterday at 6.8313 per dollar.

Under current U.S. statutes, Treasury designating China a currency manipulator would have little immediate effect. The 1988 law mandating the report requires only that Treasury begin talks with the offending country “to eliminate the unfair advantage.” The last country to be branded was China in 1994.

To contact the reporter on this story: Timothy R. Homan in Washington at thoman1@bloomberg.net

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