Over the past 20 years, Chinese authorities have engaged in a gradual but determined campaign to promote the use of the renminbi (RMB) as an international currency, with the aim of usurping the US dollar’s dominance.
In 2009, the People’s Bank of China allowed cross-border trade to be settled in RMB on a trial basis in Shanghai and Beijing, which was arguably the starting point for the currency’s internationalisation.
Since then, a number of additional initiatives have been deployed to help bolster trust in RMB and increase its usage. This has included currency swaps and clearing centres.
Undoubtedly the biggest breakthrough came in 2015, when the International Monetary Fund chose to include RMB within its special drawing rights basket. It was a signal to the rest of the world that China had well and truly established itself on the global financial stage.
However, China’s RMB internationalisation programme stalled following the 2015–16 Chinese stock market turbulence. The crisis forced Chinese authorities to deploy tight capital control restrictions to stabilise capital outflows, but confidence was dented and the acceptance of RMB stagnated.
The trade war that ensued between China and the US at the end of the decade negatively impacted acceptance even more, and was exacerbated following the Covid-19 pandemic in 2020.
A change could be on the horizon, however.
Over the past half decade, central banks worldwide have begun investigating the viability of central bank digital currencies (CBDCs) – an electronic form of fiat money. Some market participants believe the potential widespread use of CBDCs could promote the use of some currencies over others.
“Central banks that do not introduce their own digital currencies could see the demand for their currencies drop, substantially in some cases,” says Thanos Vamvakidis, global head of G10 FX strategy at Bank of America and Securities (BofA Securities).
“For the US dollar and the euro in particular, avoiding the digital era could eventually even diminish their global role.”
China would not be the first to issue a CBDC, but it would be the first major economy – and the first country with a global reserve currency – to do so.
The People’s Bank of China began researching a digital RMB (e-CNY) in 2014. Six years later, in April 2020, the central bank said its CBDC – dubbed the digital currency electronic payment (DC/EP) – was ready to launch. Pilot programmes were then established in four cities.
Challenges to internationalisation
CBDCs – and digital currencies more generally – have multiple benefits. They provide financial inclusion for those who do not have access to bank accounts, and have the potential to lower the cost and increase the speed of domestic and international payments.
Little is known about how China’s CBDC operates. In October 2020, the People’s Bank of China published a draft law laying out the legal foundations of the DC/EP, which gives the CBDC the same legal status as RMB.
As a result, it is deemed legal tender, and refusing it as a means of payment is therefore illegal.
Currently, the DC/EP is being issued through a two-tier system, whereby the People’s Bank of China has authorised eight banks, including the six largest state-owned banks, to distribute it.
The reason for this is that not all banks in China have the technical capabilities to interface directly with the central bank, but there are murmurings the central bank could authorise additional institutions in the future.
Banks participating in the pilots distribute the CBDC to members of the public via mobile e-wallets.
The hope is the DC/EP, as pilots accelerate in scope and size, will help bolster RMB’s international usage. One key milestone will be the winter Olympics, to be held in Beijing in 2022, during which overseas visitors will be granted access to the CBDC without having to open a local bank account.
Whether the CBDC is a success in international markets more broadly, however, will depend on how the People’s Bank of China and other Chinese authorities resolve underlying market issues.
“The launch of the digital RMB might marginally increase the Chinese currency’s international popularity,” says Maximilian Kaernfelt, expert at the Mercator Institute for China Studies. However, he says it will not lead to “an overnight surge in RMB usage”.
Control is one challenge China will need to overcome if e-CNY is going to be widely used. Traditionally, Chinese authorities have exerted strict control over the economic and financial system through capital controls.
This contrasts sharply with US markets, which are far more open, and where there is substantial legal protection for investors. In addition, the US dollar floats in FX markets and is allowed to fluctuate in value.
RMB meanwhile is managed with a view towards maintaining the stability of the currency, is not fully convertible and there are few signs Chinese authorities will let RMB float.
One issue of immediate concern is the impact the issuance of DC/EP may have on China’s exchange rate. Kaernfelt is mindful that a surge in RMB usage – digital or otherwise – could lead to an appreciation against the US dollar.
“This could pose a risk for domestic employment. As nice as launching the first central bank-backed digital currency would be, there are also some good reasons to wait,” he says.
Research from the Carnegie Endowment for International Peace agrees that an e-CNY network “hastily launched” under political pressure could destabilise China’s banking system, which – as the world’s largest on some measures – could in turn lead to spillover effects internationally.
Usage beyond borders
Notably, the DC/EP will need to be available beyond China’s borders if it is going to increase global RMB usage.
Yet, on paper, the DC/EP has been designed for domestic retail payments within China – small day-to-day payments involving consumers, businesses and public organisations.
In November 2020, the central bank reported just 4 million e-CNY transactions (equating to more than CNY2 billion in value) had been completed.
In comparison, in 2018, TenPay and Alipay – two of China’s payments giants – reportedly processed 1.2 billion transactions and 500 million transactions on average per day, respectively.
“Digitising RMB could increase the international usage of RMB, especially for trade partners that do not have a strong preference in favour of non-Chinese currencies, such as the US dollar or the euro,” says Jonas Gross, project manager at the Frankfurt blockchain centre.
“However, reading and interpreting central bank comments, it seems unlikely that RMB will indeed be available for non-Chinese citizens in substantial amounts.”
There are plans to encourage the use of the DC/EP for international cross-border payments, according to Wang Zin, a senior People’s Bank of China official. However, Chinese authorities are yet to make an announcement as to whether it will be available outside the country.
Even if, traditionally, China has closed off access to its currency and markets, there are signs things could be different in the long term. A retail DC/EP for small cross-border recurring payments is currently being tested in Hong Kong.
In addition, in April 2021 the People’s Bank of China partnered with a number of other central banks and the Bank for International Settlements on an m-CBDC bridge: a multi-CBDC network for cross-border payments.
This initiative “could enhance China’s regional influence over time”, says Ardarsh Sinha, a currency strategist at BofA Securities. “Ultimately, this is likely to be the actual (and more realistic) objective for China than any serious attempt to displace the US dollar’s status as the global reserve currency.”
According to David Zhou, the former vice-president of the China Investment Corporation, foreign individuals or institutions wold need only to set up DC/EP wallets in order to participate in RMB cross-border payments under the current issuer model.
“In this way, they establish a direct debtor/creditor relationship with the People’s Bank of China without involving any domestic or foreign banks as intermediaries,” he says.
“Given the openness of DC/EP system by design, it will be much easier for [individuals and institutions] to own DC/EP wallets than RMB bank accounts, thus enabling more foreign individuals and institutions to own and use DC/EP.”
Under the People’s Bank of China’s current framework, DC/EP transactions are not reliant on accounts in the traditional sense – deposit accounts at commercial banks are not required.
As a result, Zhou argues peer-to-peer transactions can occur between two wallets without the need to differentiate onshore, offshore or cross-border flows.
“This is similar to the case of any two people in the world being able to communicate via email, without knowing where the email servers are located,” he says.
One way the DC/EP could benefit Chinese authorities in the short term, if used outside its borders, is to circumvent US restrictions. It is possible the People’s Bank of China will allow Chinese-based firms to use its CBDC for transactions with people, businesses and entities that are subject to US sanctions.
US authorities currently have the power to dramatically restrict US-sanctioned Chinese companies and people access to financial services, and to limit transactions with non-Chinese sanctioned individuals.
In addition, most international transactions denominated in RMB generally rely on correspondent banking relationships and messaging through the Swift network.
In 2020, escalating tensions between the US and China threatened to exclude the Asian giant from the Swift network.
“The reliance of RMB cross-border infrastructure on Swift still has profound implications to China’s monetary sovereignty,” says Zhou.
Challenge to the dollar?
In the short term, if issued, e-CNY is unlikely to unsettle the US dollar’s dominance; if anything, it would act as a complement to its current cross-border infrastructure.
RMB is already used for settlement in China’s international trade. At this early stage, the DC/EP is more likely to be applied to smaller-value trade settlements; those in wholesale markets will likely continue to be settled in dollars.
In addition, there is still a need for DC/EP to prove its robustness. So far, user adoption has been low and there are no obvious benefits to using the instrument over other payment methods following the pilot trials.
What the People’s Bank of China’s efforts are likely to do, however, is ruffle some feathers.
The US Federal Reserve is yet to make a move into the CBDC space. Unlike its peers in China, the UK and Europe, the US central bank has been slower to investigate digital assets.
A joint project between the Federal Reserve Bank of Boston and the Massachusetts Institute of Technology has been whirring under the radar for a number of years but, so far, no concrete decisions have been made on whether to take the project further than its current research stage.
In May 2021, the Fed announced it would publish a paper later this year.
Nevertheless, Fed chairman Jerome Powell has said the central bank will not embark further into the CBDC space without Congressional approval.
Global payments processor Ripple recently published a report encouraging US authorities to move forward on CBDC projects. Among other things, Ripple noted emergency payments to people during the early stages of the pandemic would have been much easier with a CBDC.
“Now is the time for central banks to explore these issues, develop common solutions and ensure that the next evolution of money benefits more people and businesses, and makes the world better,” the report said.
Martin Chorzempa, a senior fellow at the Peterson Institute, recently testified before the US-China Economic Security Review Commission about some of the challenges e-CNY would face.
Perhaps more pessimistic than most, Chorzempa believes hype has far outpaced the reality with regard to CBDCs.
“China’s e-CNY efforts have yet to prove they will be any cheaper, more efficient, more private or more convenient than the existing domestic and international payments systems,” he said during his testimony.
“It is unlikely to represent any more a threat to the dollar’s international dominance than the current forms of RMB, at least over the short and medium terms.”
Nevertheless, he warned, nothing was certain over the long term and urged US authorities to carefully monitor China’s CBDC efforts and other digital currency innovations in the years ahead.
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