The People’s Bank of China (PBC) has rolled out pilot trials of its digital currency beginning with Shanghai, Chongqing, Shenzhen, Hangzhou, Suzhou and Xiong’an New Area. China intends to partially digitise its existing monetary base or the cash in circulation – first in the world to do so. Beginning with the integration of digital currency with the monetary system, the first step is to pay the salaries, subsidise transport and spur adoption in the retail sector. Digital means of payment are not new to the Chinese people. The use of smartphone apps such as Alipay or WeChat to pay at the grocery stores, to buy tickets or transfer money is quite widespread in the country. In 2019, around 223.34 billion electronic transactions to the tune of 347.11 trillion yuan were made in China, half of which were attributed to mobile payments.
As China emerges out of the COVID-19 pandemic, cash usage is slated to dip with people turning to contactless modes of payments. The pandemic may have throttled up the digital currency rollout for applications which apparently sound rudimentary, but the seeds of the idea were sown half a decade back. The project takes off right under the supervision of the highest echelons of political leadership, showcasing China’s prowess in FinTech (Financial Technology) innovation and possibly expediting internationalisation of the Renminbi (RMB).
A Digital RMB
The PBC, since 2014, has been working on the idea of partially digitising China’s existing monetary base, or cash in circulation, under the project called DC/EP or Digital Currency/Electronic Payments. The bank established a Digital Currency Research Institute in 2017 and launched a pilot programme in Beijing in December 2019. This endeavour aligns with the guidelines of the Fourth Plenary Session of the 19th CPC Central Committee and the Central Economic Work Conference and implements the FinTech Development Plan (2019-2021). China’s DC/EP leverages blockchain technology, but the ensuing digital currency is not a cryptocurrency. In fact, it is the electronic version of RMB, a digital legal tender pegged 1:1 to the RMB, backed by the Chinese Government, and much more stable than a typical cryptocurrency such as Bitcoin. The digital currency, which could be used without being linked to any bank account, is expected to replace physical cash in high-frequency but small denomination transactions pivoting on low issuance costs, efficiency and usability. If required, two phones in proximity can execute a contactless transaction, even doing away with the need for an internet connection. The circulation of the digital currency will be under the purview of the PBC, while the commercial banks will process the payments and deposits.
A Chamber of Digital Commerce study has examined in detail the patent applications (84 in number as of January 2020) attributed to the Digital Currency Research Institute and a few of the PBC subsidiaries, unveiling the mechanics behind the management of the digital currency, its circulation and settlement, payments processing and deposits, and the underlying distributed ledger technology. The study concludes that the circulation of the currency and its settlement and deposits will find seamless integration with the conventional banking processes, analogous to the fiat currency. Moreover, the transactions will be anonymous from the user’s perspective, but the DC/EP Platform will allow sufficient oversight on the transactions (value and identity of the transacting parties) and traceability to ferret out tax evasion, money laundering, and terror financing – in line with the existing regulatory requirements.
The project has been in the limelight, technology-wise as well as politically. The Political Bureau of the Communist Party of China (CPC) Central Committee has already undergone a group study session on the development and trend of blockchain technology in October 2019. Presiding over the session, President Xi Jinping had pressed for accelerated development of innovation in blockchain technology. More than domestic adoption, it is the global outlook of the idea which has garnered much attention, especially when China’s dissatisfaction with the dominance of the United States Dollar (USD) as the global reserve currency and its aspirations to get the RMB reckoned internationally are overt.
DC/EP and RMB’s Internationalisation
The USD holds a dominant position as investment and reserve currency under the existing international monetary system. Data from the International Monetary Fund (IMF) suggests that, as of 2019, the USD accounted for 61 per cent of all central bank foreign exchange reserves, followed by the Euro at 20 per cent, with RMB at just 1.96 per cent. Around 47 per cent of the global payments are in USD and it is involved in 88 per cent of foreign-exchange trading. More than a decade ago, in 2009, China, along with Russia, had called for “a new reserve currency” to replace the USD, basically, a currency “that is disconnected from individual nations”. The US has been accused on multiple fronts, even by the European countries, for using the SWIFT (Society for Worldwide Interbank Financial Telecommunication) system to enforce economic sanctions, as it did with Iran and Cuba. SWIFT is a global financial messaging service used by 11,000 institutions around the world to securely transmit information and instructions to enable cross-border payments. China believes that the US maintains its dominance on SWIFT’s decision-making by holding the majority in the organisation’s board. China has been extremely wary of the punitive sanctions or the threats of exclusion (both at the country and company level) from a USD-based (or the US-dominated) settlement system, and the DC/EP provides it with the much needed alternative – an RMB-based trade settlement system, seen as one of the ways to reduce the dominance of the USD in trade and financial transactions. But the prime motive behind DC/EP is to enhance international adoption of the RMB.
Internationalisation of the currency actually gives the issuing country a lot of leverages. The exporters can limit exchange rate risk, and so do the domestic enterprises and financial institutions when accessing international financial markets. It reduces the cost of capital and allows the government to finance part or all of its budget deficit by issuing debt in domestic currency on international markets, that too without drawing down its reserves. Internationalisation of the RMB could be termed as China’s long-standing aspiration, which essentially aims to create a stable international monetary environment for its own economic development. Since 2009, China has pushed aggressively for international acceptance of RMB and its use in international trade and investment, but the last five years have been quite eventful especially in the DC/EP hindsight.
The PBC had set up a ‘Cross-border Interbank Payment System’ in 2015 – its own international payments system to provide clearance and payment services for financial institutions in the cross-border RMB and offshore RMB business. In October 2016, the IMF added RMB to the Special Drawing Right (SDR) valuation basket as the fifth currency, along with the USD, Euro, Japanese Yen, and the British Pound. For inclusion into the SDR basket, the issuer of the currency (an IMF member or a monetary union that includes IMF members) has to be one of the top five world exporters, and the currency has to be widely used to make payments for international transactions and traded in the principal exchange markets. China has, thereafter, made several efforts to propel international acceptance of RMB, such as currency swap lines with foreign central banks, encouraging international trade pricing and payment settlement in RMB, and enhancing its status as value storage and reserve currency. China also attaches great importance to RMB as a reserve currency because it could then serve as a standard unit for international payments and cushion RMB against shock, but it fundamentally rests on the confidence others have in China’s ability to meet its obligations.
The DC/EP fits into China’s overarching plan for the international adoption of the RMB. It clears the way for a high table in the international monetary system at par with China’s standing in the world trade. For instance, China is the largest exporter of goods in the world trade, but this hardly reflects in the international monetary system. The RMB is already the second most-used currency in global trade, but it still falls far behind USD on many parameters. A Deutsche Bank report even dubbed China’s DC/EP as a soft or hard power tool, which can potentially erode the primacy of the USD in the global financial market if companies adopt digital RMB for their cross-border transactions. With countries adopting the DC/EP – probably beginning with the region or the countries part of the Belt and Road Initiative (BRI) – China can reduce its exposure to the US financial institutions and vulnerability to American sanctions, essentially a counter to the alleged “weaponization of the dollar”.
In the aftermath of the COVID-19 pandemic, digital means are going to be the favourable mode of transactions. Unlike physical cash, digital transactions over a digital wallet or a digital currency are traceable. Looking at the nation-wide expanse of facial recognition technology, China’s ability and intent to scale up technology innovation for intrusive surveillance programmes remain undisputed. Replacing cash with the digital currency, especially when the salaries are paid in this form, extends the Chinese Government’s surveillance net to the elusive territory of cash transactions. However, the DC/EP was conceived to serve a much bigger objective. China’s concerns arise out of its susceptibility to American punitive actions, especially when the political face-off shows no signs of dying down. A digital currency, therefore, intends to bypass US-dominated financial infrastructure, for instance, the SWIFT system.
In the next step, China is likely to extend the reach of the DC/EP to regions and countries which are part of the BRI for an RMB-based trade settlement system. Riding the technology wave, China eyes global dominance of the RMB as a reserve currency and a favourable international monetary environment for its economic development. The dominance of a currency in the global economy is often associated with the financial power of the issuing country and its ability to influence the economic calculations of others. However, it is a distant dream without transparency and the trust and confidence of others, and China is deficit of all three of them at present.