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Expertise 18.06.2020

Implications of China’s Sovereign Digital Currency

Implications of China’s Sovereign Digital Currency

The idea of a state-run digital currency (or e-RMB) has been brewing in China since 2014, with a pilot programme starting in recent months. It is a digital yuan – backed by the government.


e-RMB is stored in a digital wallet (such as a mobile device) instead of a bank account – to replace the fiat currency (i.e. yuan notes and coins). Digital transactions are conducted between two digital wallets without involving banks or credit cards.

China’s planned framework is designed with three levels – the PBoC at the top and banks at Tier Two. While in theory this should not involve banks, China’s state banks dominate its banking system and run as the operational arm of the central bank. Consumers and business users transacting through e-RMB make up Tier Three.

How widely has it been adopted?

China has been further ahead in the digital payment curve compared to most countries. e-RMB could potentially reach 225m Chinese people who do not have bank accounts and who are mostly in rural areas – potentially pulling them in to boost national consumption. Some government employees’ and public services’ salaries are already partly paid by this virtual cash.

There has been a partial rollout since April 2020 in several cities – Shenzhen, Suzhou (for transport allowances) and Chengdu. Xiong’an, a town south of Beijing which will hold the Beijing 2022 Winter Olympics, is currently testing out food and retail purchases and is targeting a full rollout at the international games.

In China, 80% of mobile phone users pay with their devices.

China’s mobile apps purchases account for 16% of gross domestic product (GDP), against 1% in the US and UK.

Before the initiative of a state-run e-RMB, the initial push for digital payments - such as Alipay of Alibaba, and WeChat Pay of Tencent - was for the ease of online shopping by the tech giants. As the largest unit of yuan is 100 or about $14, physical currency is too small and inconvenient for big-ticket items. During COVID-19 in particular, digital transactions were preferred to minimise infections.

From the policymakers’ perspective, digital payment can help to deter fraud, corruption and counterfeit notes (which was rampant). It also increases social and business governance.

What are the domestic and external implications?

Domestic implications:

Beijing has long been concerned about the digital currency monopoly by tech giants, and their impact on the financial system beyond central bank supervision. In 2013, one money market fund offered via Alipay, Yu’E Bao, was so popular that it became the world’s largest money fund within days. It rang alarm bells at PBoC about the speed and scale of money drainage from China’s bank deposit system that the central bank eventually stepped in to restrict the fund.

However, the real test will be whether Chinese consumers, usually receptive to financial innovation, are concerned about the potential state power behind e-RMB despite its convenience. As a state-owned digital currency, e-RMB may also have to deal with the potential regulatory challenges and data privacy issues faced by Facebook’s Libra.

On a positive note, e-RMB’s growth would also mean more effective ‘online’ monetary policy implementation – and along with the growth of China’s blockchain and big data development - in terms of liquidity monitoring, settlements, and external payment positions.

External implications:

The biggest, and possibly the most important, objective of e-RMB could be a shot in the arm to RMB internationalisation which has stalled since the China-US trade war started two years ago.

The slowdown is most obvious in RMB trade settlement and trade/investment use of RMB in the One-Belt-One-Road Project.

US’ China isolation policy is a wake-up call for China to seek alternative funding outside of US capital markets and particularly the US dollar (USD). The direct response is to step up the RMB capital market and RMB internationalisation.

If Chinese banks are banned from the USD global transaction system (SWIFT CODE), e-RMB could potentially aid China’s globalisation but may also pose a real challenge to USD as the world’s reserve currency.

For example, a Chinese tourist can settle with e-RMB if the oversea hotel has an e-RMB machine installed that transacts directly through the PBOC settlement system. China’s balance of payments flow may also be monitored automatically and accurately.

The same transaction by the Chinese tourist may be conducted in cryptocurrencies (Bitcoin or Ether) but they are not sovereign currency and lack the PBOC’s balance sheet and legal tender status as backing.

Potentially, this may grow much faster among emerging markets such as Africa, Latin America, Asia and Middle East, with which China already has close economic, business and strategic ties.

The same argument can be extended to countries that face economic sanctions by, for example, the US on USD transactions/settlements. These countries can circumvent US surveillance of financial flows by transacting via e-RMB once it builds into a global network. China may capitalise on e-RMB to build global strategic alliances against US’ China isolation policy.

Conclusion

Many observers fear that growing China-US tensions will extend from a trade war to financial and technology conflicts. China’s ambitious e-RMB plan may further broaden the tension’s impact by dividing the global economy into currency ‘zones’.

e-RMB may also challenge Alipay and WeChat Pay (as they are still backed by bank accounts and credit cards) and cryptocurrencies (in China, at least) as they lack the legal status and the backing of the central bank’s balance sheet.

Read the full document with charts

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Anthony Chan
Chief Asia Investment Strategist

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