China has been working on a Central Bank Digital Currency (CBDC) since 2014, but Facebook’s Libra seemed to create a new urgency. On the surface it appears the CBDC will be for domestic use, but a CBDC will simplify cross border transactions. For a long time, the country has been dissatisfied with the U.S. Dollar’s (USD) ongoing role as the global reserve currency and is committed to extending its currency’s reach.
It even has an initiative to denominate international trade credit in Renminbi (RMB) rather than dollars. And the Belt and Road Initiative has seen China extend more than $1 trillion in foreign loans, often with terms that many claim are not repayable without help.
An international Renminbi?
China overtook the U.S. as the world’s largest goods trader in 2014. The country has been the leading exporter for a decade. Hence there is a disconnect between the highest proportion of the world’s trade going through China and its denomination in USD.
Benoît Coeuré, Member of the Executive Board of the ECB, discussed the supremacy of the dollar in a recent speech. Despite the “remarkable rise of China in the global economy [and] its expanding role in international trade,” along with the creation of the Euro, the USD remains the dominant currency.
However, China has wanted to internationalize the Renminbi for longer than its leading trade status, as highlighted by a book from the Asian Development Bank. It states that in 2009, China launched a pilot scheme to use the RMB for trade settlement with Southeast Asian Nations which was subsequently expanded.
In 2010 just 1% of China’s foreign trade was denominated in RMB. That jumped to 27.8% four years later. However, the vast majority of that figure relates to Hong Kong transactions. SWIFT publishes an RMB Tracker which shows RMB’s share of international payments is just 1.88% as of April 2019.
But it’s questionable whether SWIFT is a representative measure. In 2015 China’s central bank set up its own international payment system, the China International Payment Service or CIPS. While SWIFT may have 10,000 members, CIPS stands at 900. Only 31 are “direct” members, but it includes big names such as JP MorganChase, Citibank, HSBC, BNP Paribas and Deutsche Bank. In addition to trade payments, CIPS supports instant settlement for financial transactions (Payment v Payment and Delivery versus Payment).
Recognition of the strength of the Renminbi came in 2016 when the IMF added the currency to the Special Drawing Right (SDR) basket, an international reserve. At the time, IMF Managing Director Christine Lagarde said: “The Renminbi’s inclusion reflects the progress made in reforming China’s monetary, foreign exchange, and financial systems, and acknowledges the advances made in liberalizing and improving the infrastructure of its financial markets.”
In the following year, China undertook numerous efforts to encourage international use of RMB. These lead to the Shenzen-Honk Kong stock link starting to trade, a change in the calculation of the USD-Renminbi exchange rate, and the Renminbi reaching the fifth most traded currency through Swift. China additionally ramped up spending on its Belt and Road initiative.
Spreading the money
The Belt and Road initiative aims to bolster trade between China and foreign countries by providing large loans. Since 2013, the initiative has helped to fund international projects such as high-speed railways, industrial parks, and power grids.
These loans account for “record amounts” of exported capital, according to a June paper from the Kiel Institute for the World Economy. The report estimates that China holds over $5 trillion of debt owed by other countries.
It’s having some impact. For instance, Swift’s report in June found that Africa’s payments using China’s currency increased by 123% over three years. In contrast, the continent’s payments in all currencies only rose by 28%.
The spending of huge sums abroad may be seen as a way to internationalize the Renminbi. It also allows China some leverage over foreign countries since, reportedly, the debt can be problematic to repay.
Kiel’s publication finds that some countries do not even know how much they have borrowed from China and the conditions of repayment. China usually lends funds from one state-owned entity to another, rather than government to government. This primarily affects low-income nations since their governments don’t track company debt statistics. Some researchers refer to this as the Belt and Road ‘debt trap‘.
At the Beijing Belt and Road Forum in April, the IMF’s Lagarde warned of the problematic increase in debt and that funding “should only go where it is sustainable, in all aspects.”
Some have even suggested that if a country is unable to repay its debt, one way to compensate China might be to adopt the Renminbi. And that’s not just for trade, but as the debtor country’s currency. But today that seems farfetched. And may not be desirable to China.
Despite the push for the Renminbi, last year Yicai published data showing that only 14% of Belt and Road trade was denominated in RMB. Again, there is a disconnect between where the funding is coming from and the currency used. In many cases, the countries involved tend to use USD as an international alternative, even when China is funding them.
This creates understandable dissatisfaction and not just from China. The Bank of England’s Mark Carney has commented on the dangers of relying on USD as a cross-border currency. In a speech given in August, he explained the risk of a global liquidity trap has increased since U.S. developments “have significant spillovers onto both the trade performance and the financial conditions of countries even with relatively limited direct exposure to the U.S. economy.”
In the long term, Carney sees the Renminbi as “the most likely candidate for true reserve currency status”. However, he added that the currency is not yet ready to assume the mantle. The Governor pointed out that China is the leader in trade, and the RMB is increasingly used in finance since it has become a more reliable store of value. This was one of the IMF’s key reasons for adding RMB to the SDR basket.
How the CBDC could help, and Libra could hinder
So, where does China’s digital currency come in? As an easily accessible exchange of value with clear international ambitions, the CBDC could be China’s way of challenging the dominance of the USD. The country’s central bank, the People’s Bank of China (PBOC), is said to be ready for its release.
Indeed, in the last year, China has ramped up preparations to launch its digital currency. For instance, one of the rumored distributors of the CBDC, Alipay, was required to switch to UnionPay for barcode payment clearing. UnionPay is the country’s state-owned card issuer and settlements company, like Visa or Mastercard (but bigger), and has close ties with the PBOC.
Payment services by big tech firms, like Alipay, account for 16% of China’s GDP, the highest in the world. If Alipay is indeed a distributor of the currency, then its UnionPay connection would allow China’s central bank to distribute and keep track of it easily. This works both ways because UnionPay also has plans to ramp up international adoption.
As of August, UnionPay cards are now accepted in certain stores in South Africa, Australia, New Zealand, Canada, and Russia. French supermarket Carrefour and U.S. giant Wal-Mart also process payments with UnionPay cards. The firm claims its cards can be used in 173 countries and regions.
UnionPay additionally issues cards internationally, including in Belt and Road participants Tanzania, Tajikistan, and Laos. While issuing countries and regions ‘only’ number 54, there is an extensive framework in place for widespread adoption of the Chinese CBDC.
Trade finance and supply chain are two of the leading use cases for blockchain. They align neatly with China’s trading strengths. Plus China leads the world in trade finance blockchains. For example, China Construction Bank has a platform that has already processed more than $50 billion in transactions. One of the international networks, Voltron, recently piloted a cross border transaction in Renminbi involving HSBC. Using a CBDC for on-chain transaction settlement is the optimal scenario for all players.
Jeremy Allaire, CEO of crypto finance firm Circle, summarized his view in an interview in August. For some time, China’s efforts to digitize its currency links in with the “broader concept of the internationalisation of the yuan and the Belt and Road initiative, and the desire to expand China’s role as a trade counterparty,” he said.
Such an opportunity, Allaire thinks, could “bypass the Western banking system.”
And that’s not just a foreigner’s opinion. China’s Zero One Think Tank summed up its view: “The fundamental purpose of CBDC is to promote the internationalization of the RMB, especially in the “One Belt, One Road” policy environment, to improve the convenience of RMB cross-border payment, and to enhance the RMB as a tool for international trade pricing and payment settlement, and to enhance the status of the RMB as a value storage and reserve currency.”
However, the announcement of Libra threw a spanner in the works for the CBDC. The ECB’s Benoît Coeuré suggested that ‘stablecoins’ have the greatest chance of supplanting the dollar. But he focuses on the possible impact of private stablecoins, run by companies. “Libra has undoubtedly been a wake-up call for central banks to strengthen their efforts to improve existing payment systems,” Coeuré explained.
Libra will be backed by a basket of currencies, including the U.S. Dollar. The Renminbi is not part of the Libra basket, and Facebook’s giant userbase does not include China’s residents. Hence, there are mounting concerns over how it could affect the Renminbi. If the CBDC was focused purely domestically would China care that much about Libra?
The PBOC’s Wang Xin explained his view of this: “If the digital currency is closely associated with the U.S. dollar, it could create a scenario under which sovereign currencies would coexist with U.S. dollar-centric digital currencies.”
“There would be in essence one boss, that is the U.S. dollar and the United States,” continued Wang Xin. “If so, it would bring a series of economic, financial and even international policy consequences.”
A fellow Director at the central bank, Mu Changchun, has been even more vocal regarding Libra. At the beginning of September, he released a training course on Libra and digital currencies, stating that Libra’s announcement “shocked the central bank[s] around the world.”
“I think it is not excessive to regard Libra as a potential world-class monetary change,” he wrote. “…if this change is not handled well, it is likely to be a huge hidden danger.”
Despite Libra’s recent setbacks, China’s goal of internationalizing the Renminbi has been threatened by Libra. So the race is on for China to roll out its CBDC.
Facebook and Libra’s David Marcus concurs re the CBDC’s international aims. “I think their [China’s] goal is not domestic. It’s really broad and it has the objective of rewiring the financial networks of a lot of countries with digital assets that they control.”
With contributions from Nicky Morris