At a time when the world is fighting the pandemic, news of the trial launch of Central Bank Digital Currency (CBDC) – yuan (renminbi) by the People’s Bank of China (PBoC) has gained global attention. It is also being flaunted as challenging the supremacy of the US dollar. Though a strategic move by China, many other reinforcing policies will have to be institutionalised and it will be long before it can make an impact in cross-border payment and settlement system.
Initially, the digital currency will be accessible with its specific app within domestic financial markets, and that too after the trial is through. But China will be the first big country to come up with CBDC, which will be tested across four big cities — Shenzhen, Chengdu, Suzhou and Beijing. It is expected to be used in the 2022 Winter Olympics.
In a digital ecosystem where customised apps are a part of normal utility, floating of CBDC can also be the logical development to reduce the drudgery of administrative and logistical costs of using paper currency. It cannot completely substitute physical currency but can reduce the burden. One key difference is that it doesn’t use blockchain technology to record and verify transactions since PBoC will manage it through a centralised system.
Every user will have a public key as a personal identifier and a private key to make secure transactions. Counterparties in a transaction can be anonymous though the PBoC will know all users and be able to access their transaction records. Since a large number of digitally literate Chinese consumers, estimated close to a billion, use Alipay and WeChat digital wallets, the digital yuan will gain more prominence as it also works offline through peer-to-peer touch payments and need not be linked to debit or credit cards. The digital currency app includes functions such as QR code payments, remittances, receiving money, and person-to-person payments by simply touching handsets.
Unlike bitcoins, it is like a digital wallet fully controlled, owned and operated by the central bank in a tamper-proof system. It can track money flows and prevent frauds. When the digital yuan stabilises, it could gradually replace 30-50% of the domestic money supply.
It need not be seen as a threat to any currency that is used in the settlement of international trade transactions. The near term utility of digital yuan is to enable retail utility transactions. It will reduce currency handling; enable better capturing of spending trends with improved tax compliance. Way forward, using data analytics, the Chinese central bank will be able to improve the efficiency of monetary policy dispensation.
On CBDC substituting an internationally accepted currency, it has to be borne in mind that such a currency should be fully or freely convertible that can be traded without any conditions or limits. Generally, fully convertible currencies come from more stable or wealthy countries that are market-driven with least interventions. All major international currencies such as the US dollar, euro, Japanese yen, pound sterling, are fully convertible currencies. But yuan is convertible only for current account transactions and not for capital account transactions.
International trade trends indicate that though China’s total trade in goods reached $4.6 trillion or 12.4% of global trade in 2018 against total trade volume of $19.48 trillion, the global invoicing preference continues to be dominated in US $. Though China is known to be the world’s largest trader and exporter, yet less than 2% of SWIFT transactions are denominated in renminbi. Similarly, the yuan is only the fifth-most traded currency in terms of volume on forex exchanges.
A large volume of dollar invoicing in international trade creates an increased demand for safe dollar deposits, thereby conferring an exorbitant privilege on the dollar in terms of reduced borrowing costs. Such low dollar-denominated borrowing costs make it attractive for non-US exporters to invoice their sales in dollars so that they can easily tap the cheap dollar funding. The dollar is also the predominant reserve currency, accounting for 64% of worldwide official foreign exchange reserves. The euro is in second place at 20% and the yen is in third at 4% (ECB Staff (2017)).
The Chinese move is not a sudden development. In 2014, China launched a project, ‘Digital Currency / Electronic Payment’, to provide an alternative to cash and improve efficiency of transactions across the financial system. The joint report of the Committee on Payments and Market Infrastructures and the Markets Committee of Bank for International Settlements (BIS) released in March 2018 provided an initial analysis of CBDCs along with their implications for payments, monetary policy, financial stability and points of consideration before the launch of CBDCs.
The BIS came up with yet another set of guidance on April 3 when there were increased apprehensions that the virus could be transmitted through handling of physical currency. Irrespective of whether the concerns are justified, perceptions that the currency could spread pathogens may change payment behaviour. Such attitudinal change may ultimately lead central banks across the globe to adopt digital currency as an alternative payment method. These developments might have hastened the rollout of Chinese digital currency. Even Bank of Korea has begun testing its digital currency.
Digital yuan will have a wider impact in domestic markets for retail transactions and can reduce the use of physical currency. It can be a better means to control fraud with enhanced cybersecurity standards and the PBoC will have a better grip on end use of the currency. It will be useful to businesses that have significant exposure to Chinese markets.
As far as positioning it for dominant international trade transactions are concerned, a lot of reinforcing measures will be required. Positioning yuan as competing currency with US$ and euro can be an end state objective of China but a farsighted reality. A strategic move to digitise yuan could be a good beginning but it is miles away from occupying a strategic place in international payment and settlement system and assuming the role of a reserve currency.
(The author is Adjunct Professor, Institute of Insurance and Risk Management, Hyderabad)
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