China may become the first major country to launch its currency in a digital form, aiming to get a better grip on the money in circulation and raise the stature of the yuan as a global reserve that may rival the U.S. dollar some day.
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The People's Bank of China trialed the digital yuan in four large cities earlier this year. That was, in part, to prepare for the 2022 Winter Olympic Games in Beijing, Beijing News reported on April 19.
Such central bank-issued digital currencies, called CBDCs, will be fiat money, but in a digital form. They will be a store of value in and of themselves, in contrast with digital payments, which are representations of money. China's CBDC would make the world's second-biggest economy pioneer what experts believe may become a trend.
"It would have meaningful implications on how monetary policies can [or] should be conducted in the future," David Wang, head of China economics at Credit Suisse, said in comments emailed to S&P Global Market Intelligence. It will likely be the first digital currency formally introduced by an official monetary authority, Wang said.
Taking control
More than bragging rights, the digital yuan will help the central bank to partly take back control of cash that is circulated in the market. China's mobile payments market is currently dominated by Alipay and Tencent's WeChat Pay, which means that users deposit their money in these technology companies, draining cash out of the traditional banking system. PBOC Governor Yi Gang said last year that big tech companies "bring to us a lot of challenges and financial risks".
"China's CBDC will allow traditional financial institutions, such as banks, to better compete with third party payment network providers such as Alipay or WeChat [that] account for over 90% of all mobile payment transactions in China," said Galen Law-Kun of the cryptocurrencies team at PriceWaterhouseCoopers. "The goal of China's CBDC program is to replace paper cash and make peer-to-peer transactions more secure and efficient," he said.
By creating its own digital currency, the PBOC will be able to take underlying ownership of the cash distributed digitally in the market, even if users still use Alipay and WeChat pay as their primary e-wallets. The central bank has, however, not announced a formal date to launch the digital currency.
A Bank for International Settlements report in January said that 20% of the world's central banks are looking to launch a digital currency of their own in the next six years. The coronavirus pandemic is likely to accelerate that development, the Basel, Switzerland-based global central banks' body said in June. Not only will CBDCs eliminate hygiene concerns by the use of contaminated cash, but digital currencies could also help governments distribute stimulus money directly to businesses and individuals in a future crisis, industry insiders told S&P Global Market Intelligence.
On Aug. 13, the Federal Reserve announced that it is working with researchers at the Massachusetts Institute of Technology to test how a CBDC might impact its operations. And in Europe, CBDC development has been ongoing in Switzerland, the U.K., France, and the Netherlands.
China's CBDC differentiates itself from other central banks around the world as it is retail-focused and aims to replace cash in circulation, known as M0, said Charles D'Haussy, director at ConsenSys, a blockchain software company. "Most [other] central banks have been first focusing on wholesale CBDC and now are working on retail CBDCs."
Though it may start by being used only at the national level, many in the industry believe it could travel along the nation's Belt and Road plan to go international, Law-Kun said. The Belt and Road initiative, China's reimagining of the Silk Road, is seen by some experts as an avenue for China to enforce the use of the yuan at least on a regional scale.
"The BRI region is China's natural region to succeed in building a multilateral currency order, to rival the 20th-century U.S.-dominated global monetary system," said Shirley Ze Yu, a political economist and a fellow at Harvard Kennedy School's Ash Center.
To be sure, China needs to allow the yuan to float more freely. The digital yuan won't be "a standalone entity," Yu said, adding, the digital yuan cannot become a global center currency, unless the yuan "itself becomes one."
The depth and width of the capital market is still the most significant variable, because no country or individuals would hold on to a yuan-denominated asset if there is insufficient market liquidity globally. The yuan "has a long road to travel still," she said.
Yu said that it is crucial for China to internationalize the yuan now, especially since the U.S. dollar has enjoyed its reign as "the ultimate currency of last resort" post-World War II and dominates the global monetary system. The need for China to press the gas pedal on its yuan internationalization agenda also became more pronounced recently as the U.S. announced sanctions against Chinese and Hong Kong officials. China has to be prepared for its banks to be excluded from international monetary clearing systems, including SWIFT and CHIPS systems, down the line, she said.
The need for China to internationalize its currency "is both strategic and opportune," Yu said. "In the current decade, we might inevitably see two parallel global monetary systems" -- the dollar-based system and a rising and regional yuan-based system.