The development of China's digital yuan is another step in the process of internationalization of the renminbi. Will this threaten the international dominance of the dollar.
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Central banks around the world are implementing digital solutions to improve the efficiency of the financial system. Among the G20 countries, 19 out of 20 countries are exploring the idea of Central Bank Digital Currency (CBDC), 16 are already in the development stage. China seems to be at the forefront of CBDC development with ambitions to change the global economic system.
What is CBDC?
The Central Bank Digital Currency (CBDC) is a digital token that acts as a fully digital version of the cash issued and guaranteed by the central bank. CBDCs are unlike cryptocurrencies, which are decentralized and have values corresponding to fiat currencies such as the dollar or euro, in the case of fixed coins. Central banks around the world are experimenting with the idea of CBDCs to develop efficient ways for direct monetary and fiscal policy, improve financial availability and promote economic inclusion by establishing competition in domestic markets. The People's Bank of China (PBoC) has been a pioneer in the CBDC field since 2014, with the development of the digital yuan that puts them ahead of many other countries, it is still in the research and planning phase. This initial development allows China to internationalize the renminbi (RMB) and hamper the dominance of the dollar.
The dominance of the dollar
The Bretton Woods system, established in 1944, paved the way for the US dollar to emerge as the world's international reserve currency. As a result, the global economy and financial markets were woven into the dollar and the US economy. Today, even though China is the world's largest trading partner, the RMB is still less than 2 percent of the world's reserve currency. The disparity in trade and currency conditions in the global economy is a cause for concern for China, which is structurally indebted to the dollar-dominated economy.
Central banks around the world are experimenting with the idea of CBDCs to develop efficient ways for direct monetary and fiscal policy, improve financial availability and promote economic inclusion by establishing competition in domestic markets.
At a time when China's economic strength is growing rapidly, the continued turmoil of the US dollar in global markets is a matter of concern for the Chinese people. The dominance of the dollar allows the United States (US) to impose sanctions on Chinese companies by separating them from the global payment railways. A large number of payments around the world use dollars to settle rail transactions, giving the US an upper hand to passively control cross-border transactions. This could be an unrealistic problem for other central banks around the world.
Digital yuan development
Cross-Border Interbank Payment Service (CIPS)
PBoC created the Cross-Border Inter-Bank Payment Service (CIPS) in 2015 to challenge the dollar-dominated global payment system. Accepted by major banks and financial institutions, including Citibank, HSBC, and JPMorgan Chase, CIPS facilitates RMB transactions globally. This effort to internationalize RMB has its limitations, as compared to The Society for Worldwide Interbank Financial Telecommunication's (SWIFT), CIPS has only 1,300 participants with 10,000 participants. However, it should be noted that the functions of CIPS and SWIFT are different. SWIFT does not move any funds. It's just a secure messaging system that allows participating banks to communicate with each other. CIPS, on the other hand, is a RMB clearing system, similar to the US clearing house Interbank Payments System (CHIPS),
To achieve the goals envisaged by the latest Financial Standardization Five-Year Plan (2021-2025) issued in early 2022, China needs to increase the network and effectiveness of CIPS to further improve the internationalization of the RMB. Importantly, despite China's inclusion in the Special Drawing Rights Basket by the IMF in 2016, it must also make structural economic changes to make the RMB an internationally recognized safe asset and strengthen its share of total global reserves.
CIPS, on the other hand, is an RMB clearing system, similar to the US clearing house Interbank Payments System (CHIPS), which uses the SWIFT network to settle dollar-denominated transactions.
Belt and Road Initiative (BRI)
Large internationalization of the RMB is also critical to the success of China’s Belt and Road Initiative (BRI), a strategic plan to connect the main economic corridors in Asia, Europe and Africa by enabling more comprehensive trade and investment opportunities between China and nearly seventy. BRI aims to develop mutual benefits by investing in infrastructure and creating additional markets for Chinese products and services in the participating economies. An important part of all BRI investments is in developing infrastructure projects - highways, railway networks, shipping ports and industrial parks. In addition to developing soft power in many countries, BRI allows China to issue RMB-denominated loans and expand the use of the currency in Asia, Europe and Africa.
However, since the inception of BRI, the US dollar has remained the main currency of investment - only 14 per cent of all loans are denominated in RMB. Such an imbalance is in stark contrast to the rise in BRI investment and China's global economic situation, which is in line with China's current state of trade and RMB usage. According to the Asian Development Bank, Asia needs to invest US $ 26 trillion in infrastructure over the next decade, and China is in a unique position to do so. The digital yuan allows China to issue more loans in RMB and strengthen networks and mechanisms for debt repayment. For example, China is now the largest trading partner with 25 BRI-participating countries and has currency-swap agreements with 20 countries. In addition,
BRI aims to develop mutual benefits in participating economies by investing in infrastructure and creating additional markets for Chinese products and services.
Another way for the yuan to expand is in the form of debt in Africa. China is the largest bilateral debtor to African countries such as Zambia and Djibouti, forcing them to deposit digital yuan in reserves to repay their loans. In addition, CBDCs enhance the efficiency of cross-border transactions, making the digital yuan ideal for remittances in Africa.
Newborn Yuan
Despite such advantages, the lack of confidence in the currency is perhaps the most serious challenge to the internationalization of the RMB. The adoption of the digital yuan will require a guarantee from Chinese institutions. The growing trade war between the US and China and the coronavirus epidemic have further polarized the world and created additional barriers for the yuan. Still, BRI could be the catalyst for the digital yuan in many Asian and African countries. The growth of the digital yuan also depends on the global acceptance of CBDCs and how they integrate and transform into traditional financial systems.
There is a fundamental difference between the RMB and the dollar that shapes their international use. The dollar is mainly market-driven, while the RMB is government-driven or state-driven. China’s economic system is limited and limited by its economic and political system. The use of it by liberal economies boosted the dollar's value as an international reserve currency. On the other hand, China manages capital control over most aspects of its economy primarily to manage RMB volatility.
The growth of the digital yuan also depends on the global acceptance of CBDCs and how they integrate and transform into traditional financial systems.
Despite the low adoption globally, China is still at the forefront of the race for CBDC research and implementation. The digital yuan may not yet be an international currency, but it is certainly gaining momentum in China. The domestic use of the digital yuan could affect many international currencies as China is the world's second largest economy and also the world's largest trading partner. This can be seen as a threat to the dominance of the dollar or as an alternative to the dollar-dominated global financial system. It is too early to assess the impact of the digital yuan, but it could be a great opportunity for governments around the world to develop CBDCs to incorporate insights into China's digital yuan. For example, digital yuan transactions can be made without an Internet connection, which can be useful for financial inclusion programs in areas without Internet infrastructure
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