It has been nearly 400 years since the world last used a Chinese currency as an international medium of exchange. At the time, China was a major global trading power and commanded nearly 30% of global GDP in PPP terms. While modern China has similar aspirations, it faces a starkly more internationalized global economy driven by a US dollar and polarized geopolitical interests. Nonetheless, China’s desire for an internationalized currency predates its entrance into the WTO in 2001 and drove its pursuit of Special Drawing Rights (“SDR”) inclusion in 2016.
China now plans to bolster its global authority by leveraging a PBOC-backed digital currency to lubricate cross border trade and further the RMB’s internationalization. While unlikely to dethrone the USD as the global reserve currency in the near-term, a digital RMB will still significantly challenge the West’s ability to leverage the US financial system to shape the geopolitical environment and, should Sino-American interests diverge, provide China with an alternative outlet with which to pursue its national interests.
Overview & Scope
China’s development of its digital RMB can be broken down into a few distinct milestones. As early as 2014, The People’s Bank of China (“PBOC”) assembled a task force to begin research on digital currency solutions through a project called Digital Currency / Electronic Payment (“DCEP”). In 2017, the PBOC created the Digital Currency Research Institute and, at the end of 2019, the digital currency entered a real-world pilot in semi-open environments within Shenzhen and Suzhou. The PBOC plans to release the digital RMB nationwide as soon as late 2020.
The digital RMB is akin to a form of digital legal tender – controlled by the PBOC and fully backed by reserves. The PBOC has sole oversight of the digital RMB and plans to circulate it through Chinese financial institutions as opposed to directly to the consumer. The PBOC has recently filed more than 80 patents related to its digital RMB plans, including technologies related to the issuance and supply of a central bank digital currency, a system for interbank settlements that uses the currency, and the integration of digital currency wallets into existing retail bank accounts. Currently, the distribution and payments infrastructure is supported by 23 institutions spanning 9 operational categories.
A central bank digital currency could have two primary models – a widely accessible payment tool available to the public for retail transactions and a currency through which MNCs transact. For retail transactions, a digital RMB could be able to record information of real-time transactions and, through big data analytics, identify criminal transactions and money laundering. In global commerce, a digital RMB could increase the efficiency of securities settlements and cross border payments while offering a more stable currency value. According to Qian Xuening, an economist with the Institute of Economics at the Chinese Academy of Social Sciences, “The original idea of both models is to replace and develop the existing paper currency and electronic accounts, in order to enhance monetary stability, improve financial efficiency and monetary policy functions.” Depending on the capabilities that the PBOC-backed digital RMB supports (below), it is likely that the digital currency will improve the efficiency of transactions across the financial system on both a retail- and commercial-scale while advancing the PBOC’s ambitions of internationalizing the RMB.
Key Design Features of Central Bank Money
According to China’s Zero One Think Tank (link in Chinese), the fundamental purpose of a centrally-backed digital currency is to improve the convenience of RMB cross-border payment, to enhance the RMB as a tool for international trade pricing and payment settlement, and to further the international status of the RMB as a value storage and reserve currency. China has been making notable progress in positioning its markets for international leadership; however, Beijing recognizes that the country is severely limited in expanding its international influence by a USD-dominated global financial system. The primary goal of the digital RMB is to internationalize the Chinese currency to a level that can eventually challenge USD supremacy.
China’s relationship with the global economy has been shifting since Deng Xiaoping began the Opening Up and Reform movement (link in Chinese). As noted in The China Guys’ article Chinese Markets Primed to Shine as Coronavirus Outbreak Fades, “The new special economic zones and other progressive economic measures generated an unprecedented deluge of capital that distanced China from its isolationist past. This development gained momentum and significantly contributed to China’s rapid economic growth in the last 35 years.” Nowadays, China stands as the world’s second largest economy, largest exporter of goods, and the largest trading nation in the world.
Furthermore, China’s share of world consumer spending increased from 2% in 1980 to 12% in 2018 in dollar terms, putting the country on track to become one of the world’s biggest consumer markets before the end of the decade. Poignantly, despite a marked growth in consumption, China has been reducing its relative exposure to the world while the world has been increasing its exposure to China, signifying an opening window of opportunity for China to begin taking steps to fortify the RMB’s role in the global trade ecosystem.
China-World Exposure Index (trade, technology, and capital)
Due to China’s ubiquitous trade influence, an emerging digital RMB inherently holds global significance. From 2000 through 2015, the RMB’s share as a settlement currency in China’s trade increased from 0% to 25%. There remains a disconnect between the highest proportion of the world’s trade going through China and its denomination in USD. The RMB strongly lags behind other major global currencies in international financial transactions unrelated to trade. According to SWIFT’s RMB Tracker, the RMB was responsible for just 1.94% of total global payments in December 2019, within the expected range established by its historical 3-year average. Despite its dominant position within the global economy, China has so far failed to convert its economic strength into international RMB influence and properly incentivize widespread corporate RMB use.
RMB Exposure to Global Payments
With alternative world currencies commanding approximately 98% of total global payments, foreign central banks attach a relatively small value to RMB holdings. As such, global demand for RMB reserves critically lags behind that of other major world currencies – particularly the USD and Euro. As of Q4 2019, RMB reserves totaled a paltry 2% of total currency reserves, significantly trailing the USD at 60.9% and the Euro at 20.5%. Without a significant boost to foreign holdings, the RMB will struggle to accumulate sufficient influence to challenge the USD as the global reserve currency.
Composite FOREX Reserves as of Q4 2019
At present, it appears unlikely that the RMB can stimulate global demand due to tight Chinese controls on the country’s capital accounts. While China’s current account has been freely traded since 2009, the capital account remains largely closed with flows in and out of China heavily restricted. In order to promote the RMB to reserve currency status, China would have to lift these controls that insulate China’s economy from rapid inflows or outflows of funds and allow freer movement of its exchange rate. Otherwise, countries will be unwilling to hold large amounts of the RMB if it does not reflect true market conditions. China has signaled an appetite to liberalize its capital account but the pace and sequencing of reforms remain uncertain.
The USD Remains the Dominant Currency in the Intl. Monetary System (%)
However, China’s release of the digital RMB comes at a remarkably auspicious time. As observed by Forbes, China has a longstanding ambition to internationalize the RMB and is relying more on policy initiatives rather than structural factors to achieve this aim. China’s patient strategy to internationalize its currency is broadly consistent with the timing of the domestic reforms needed for China to transition to a more market-oriented economy. Saliently, China has begun providing unprecedented access to financial markets for foreign players over recent months and is continuing to reform its financial system to stimulate market competition.
Open financial markets are an enabler of global business and ultimately contribute to a more robust financial system. China is grappling with a rapidly transforming economy and the internationalization of the RMB is but one of its many political and economic objectives. While a digital RMB and China’s recent market reforms may not be the direct catalysts required to achieve China’s ambitions for an international RMB, they represent the patient approach that the PBOC is taking to allow new and previous initiatives to coalesce and drive the process gradually.
One Belt One Road (OBOR)
The OBOR initiative aims to foster trade between China and foreign countries by providing large loans and access to a preferential cross border trade ecosystem. Since the initiative began in 2013, China has extended more than US$1t in funding for massive infrastructure projects across both developed and emerging economies. According to a June 2019 report from the Kiel Institute for the World Economy, these loans account for “record amounts” of exported capital and estimates that China holds over US$5t of debt owed by other countries.
While the initiative is considered a major potential driver of RMB internationalization, China has not required these projects to be denominated in RMB. However, more than 30 member countries of the OBOR initiative have signed onto cooperative bilateral swap agreements with China and established RMB-denominated credit facilities totalling CN￥3.3t (US$467b). While these credit solutions have largely gone unused, they still support China’s broader aim to drive RMB holdings going forward – an initiative boosted by a digital RMB.
Integrating a digital RMB into the OBOR trade ecosystem could spur RMB-denominated cross border trade and significantly boost China’s nontangible ROI on OBOR-related investments. Modern cross border trade suffers from long payment periods, inefficient payment processes, and expensive settlement costs. Currently, corporates wait an average of nearly 70 days for payment from business customers, with inefficient internal processes leading to costly payment delays.
According to a PBOC-released report outlining the technological infrastructure supporting the digital RMB, while the digital currency would not necessarily rely on blockchain technology, transactions would instead be split into execution instructions corresponding to each party and generate execution priorities for each instruction. The instruction list can be tracked back for the lifespan of the currency, allowing traceable transactions. This could conceivably enable the near-instantaneous issuance of pass-through receivables and debt obligations while reducing costly processing and settlement fees within trade finance, thereby alleviating many of the problems burdening the current cross border trade environment.
East Asia Forum suggests that because China has widespread capital controls but an open trade account, it relies heavily on encouraging greater RMB trade invoicing. Substantial increases in the use of RMB for trade settlement will necessitate use for investment, from which demand for RMB reserves will follow, albeit slowly. The efficiencies introduced by the digital RMB and its cross border trade infrastructure should incentivize corporate use of the RMB and drive heavier RMB trade invoicing, particularly in OBOR-related infrastructure projects – toppling the first domino in the path for RMB internationalization.
The Nissan Case
Amid Nissan’s primary automobile manufacturing operations, it engages in daily cross border trade by sourcing components from across the globe. Because of the complexity involved in automobile manufacturing, Nissan must engage multiple tiers of suppliers to source everything from tires and windows to auto chassis. In turn, Nissan’s auto chassis suppliers have additional suppliers from which to source fittings, and those suppliers have suppliers from which they source sheet metal. From beginning to end, Nissan heads a complex web of turnkey suppliers that trade components up the supply chain to ultimately manufacture a vehicle. Within a supply chain as deep as Nissan’s, suppliers at each subsequent tier will incur increasingly higher fees and delays when processing receivables and debt obligations.
The digital RMB and its transaction infrastructure will allow for the instantaneous flow of receivables and debt obligations up and down the supply chain. A receivable from Nissan could be directly passed through multiple tiers without being subject to fees and delays as each supplier en route processes it. Once the final recipient redeems the receivable, the financial institution that settles and clears the deposit can trace the origin of the receivable and directly engage with Nissan as the counterparty – thus alleviating the long payment periods, inefficient payment processes, and expensive settlement costs afflicting today’s cross border trade environment.
Looking to the Future
China has long been a driving force in the global fintech environment and boasts one of the most advanced digital economies in the world. On the surface, a digital RMB appears to primarily target domestic use; however, China has a grander vision.
Cognizant of its commanding influence on the global trade environment, China has been patiently developing a resilient financial system by steadily attracting foreign investment through liberalized market access for foreign entrants and encouraging a more efficient market through increased competition. All the while, China has been planning to drive global demand for the RMB by introducing a PBOC-backed digital currency into OBOR and other Chinese-driven global trade initiatives to lubricate cross border trade.
While a digital RMB and China’s recent market reforms alone may not be enough to achieve China’s ambitions for an international RMB, the strategy represents the PBOC’s methodical approach to laying the bricks for the road to RMB internationalization.