The implications for China and the world of eCNY

  • In this Focus we detail what is known about how China’s central bank digital currency (CBDC) will operate, when it will launch, what the People’s Bank is trying to achieve, and whether it will succeed. One conclusion is that the launch of eCNY will do nothing to relax the constraints that have prevented the renminbi being widely adopted in international trade or as a reserve currency. Indeed, we argue that the People’s Bank will have to compel eCNY’s use for it even to take off within China.
  • There is a striking disconnect between how much is talked about China’s CBDC and how little has been confirmed on how it will operate. The reason, we suspect is that details still haven’t been pinned down. The “digital wallets” currently being trialled around China may be better thought of as prototypes testing use cases rather than stable products ready for release. Indeed, key backers of the project within the People’s Bank appear to disagree over whether eCNY is strictly speaking a CBDC at all. Many think that a launch is imminent. But we expect trials and pilot projects to continue for another couple of years.
  • The key driver of the PBOC’s interest in a CBDC is China’s rapid adoption of mobile payments. Most day-to-day retail payments now go through Alipay and WeChat Pay. That presents a systemic risk and, as physical cash becomes less widely accepted, it arguably undermines the central bank’s job of providing a readily-accessible publicly-issued means of payment. Other central banks have similar concerns. But these two firms’ control of payments has also unnerved a leadership that is not comfortable letting private actors hold significant power in any sphere in China.
  • The challenge facing the PBOC is that, no matter how well designed, eCNY offers consumers no substantial benefits over Alipay and WeChat Pay which are well entrenched in both the online and offline worlds. And neither Alipay and WeChat Pay nor the banks have any commercial reason to support the new system. The former would lose transaction fees and data on consumer behaviour. The latter could face higher funding costs. We suspect that the leadership ultimately will compel eCNY’s use, including as the payment system underpinning third-party services, to achieve its end of reasserting control of payments.
  • CBDCs open up new possibilities both for fiscal and monetary policy. The PBOC has been cautious in its public statements, which suggests that novel ideas like “programmable money” aren’t currently under consideration. The PBOC has ruled out charging or paying interest on eCNY balances. Fiscal handouts direct into every resident’s eCNY wallet would become viable – but don’t appear likely to be a finance ministry priority: the post-lockdown stimulus in 2020 was still the old-fashioned, investment-intensive sort.
  • eCNY could make cross-border transactions more efficient than they are with CNH, but it wouldn’t address the structural factors that have inhibited the renminbi’s adoption abroad. CNH has been available for over a decade, yet the renminbi still accounts for only 2% of global cross-border trade settlement, foreign exchange spot trades and foreign exchange reserves. Large-scale global use requires foreigners to both want and be able to buy and sell Chinese financial assets in large volumes at will. But that would require capital controls to be removed, which would threaten financial stability. China’s leadership would like to elevate the renminbi’s global standing, but not at the cost of a financial crisis.
  • However, eCNY would provide a partial safety net in the event of forced financial decoupling by the US. As is the case domestically, a key part of the global appeal of eCNY for China’s leadership is that it would give them a payments system they controlled.

The People’s Bank is getting closer to launching a new digital currency. This Focus sets out what is currently known about the project and considers the broader economic and financial implications.

We answer the following questions:

What are CBDCs?

Central Bank Digital Currencies (CBDCs) are having a moment in the sun. (See Chart 1.) According to a BIS report published in 2020, 80% of central banks are investigating their use.

The term Central Bank Digital Currency isn’t particularly helpful because in general use “currency” and “money” are interchangeable and most money is already digital.

But currency has a narrower definition, referring only to money that is legal tender: in today’s world that comprises only notes and coins issued by a central bank. Central bank reserve money is digital – and in China and other places with large central bank balance sheets it is a bigger part of central bank liabilities than notes and coins. (See Chart 2.) But reserve money isn’t “currency” in this narrow sense. Bank deposits are digital but not liabilities of a central bank. Uniquely, therefore, CBDCs are a digital claim on the central bank that is legal tender. (See Chart 3.)

Chart 1: Google Searches for "Central Bank Digital Currency" or CBDC (normalised index, max = 100)

Source: Google Trends

Chart 2: Central Bank Money (% of GDP, 2019)

Sources: CEIC, BIS, Capital Economics

Chart 3: Different Types of Money

Source: Capital Economics

Many different forms of CBDC have been proposed but they all have in common that they are a digital claim on the central bank that is widely available. Some “wholesale” CBDCs have been proposed that would in principle allow more efficient processing of wholesale transactions. They could be made accessible both to banks and non-bank financial firms. But most of the interest currently is in “retail” CBDCs that could also be held by non-financial firms and individuals, and foreigners as well as residents. They would be managed as online accounts or as digital wallets sitting on phones, watches, cards, and potentially cars and internet-linked devices.

What benefits (and risks) do CBDCs bring?

CBDCs have multiple attractions for central banks. Several (including the PBOC) started to consider them out of concern that use of crypto-currencies or digital currencies managed by private firms (like Facebook) could take off, reducing their monetary sovereignty. If commercial activity is conducted with cryptocurrencies, what does that do to financial stability and the conduct of monetary policy? CBDCs could head off this threat by incorporating some of the benefits of new payment technologies into the public payments system. (The other element of the PBOC’s response has been to tighten regulation of private payments providers and to throttle crypto-currency adoption – trading on Chinese exchanges was banned in 2017, and a ban on payments providers accepting cryptocurrencies was tightened this month.)

A separate concern is that the emergence of non-bank payments networks creates systemic risk: central banks have a duty to ensure that payments networks are robust, not vulnerable to the failure of one or two firms and not abused by monopoly providers. Central banks may choose to allow private payments networks to coexist with a CBDC, but a CBDC provides redundancy.

A third consideration is financial inclusion: as notes and coins become less easily available and less widely accepted, CBDCs can ensure that those without bank accounts aren’t excluded.

Fourth, CBDCs potentially allow central banks to monitor payments flows in real time.

Finally, CBDCs could open new policy options as we discuss in the context of China below.

All of these are however primarily attractions for central banks. The advantages of CBDCs for most users are less clear-cut.

For countries with antiquated payments systems, CBDCs should increase efficiency. They allow real-time clearing. They can facilitate offline mobile payment. But neither is a pressing concern for countries where efficient real-time mobile payment is already ubiquitous, including China.

Depending on the design chosen, CBDCs can be opened up to people without bank accounts. That means they should also make life easier for tourists visiting countries where unfamiliar mobile payments systems dominate. More generally, they should speed up and otherwise improve cross-border payments, which are particularly prone to errors.

In time, widespread adoption of digital currency might lead to new uses. CBDC wallets would essentially be apps that could be linked to other services or devices – for example, to an internet-connected smart meter to pay a bill. If transactions were more efficient, micropayments of less than one fen (or one cent) might be viable. Payments could be triggered automatically if pre-determined condition are met (e.g. a parcel being delivered). A programmable wallet might open a world of uses that are hard to predict. But these new features remain theoretical and would not be introduced until central banks were confident that CBDCs had won widespread acceptance.

And as things stand, for most people in most places, CBDCs wouldn’t solve any pressing problem. For consumers and firms, perhaps the strongest argument in favour of their use today may be that unlike other digital money in widespread use, CBDCs would be a liability of the state. As a result, there would no counterparty risk in holding large CBDC balances or in transacting using CBDCs. But is this a strong enough reason to drive widespread take-up? Banks are already underpinned by deposit insurance or implicit government backstops.

A lack of clear advantages for users over other forms of digital payment is likely to be the main constraint on the adoption of CBDCs. If central banks are nonetheless convinced of their value, they may have to compel their use.

But there are concerns for central banks too – primarily that CBDCs could be destabilising if they triggered a flight of deposits from banks (see the discussion of disintermediation in the next section).

How will China’s digital currency work?

Most major central banks appear in no rush to introduce them. But the PBOC gives every impression of being on the verge of a launch.

The PBOC has published few details of how its CBDC will work, which raises questions as to whether the project is as advanced as officials sometimes suggest. This section pieces together details from speeches and comments by PBOC officials known to be involved in the project. These comments haven’t always been consistent though, which might signal that some issues haven’t been nailed down. And some of the gaps in our knowledge are significant. One of them, as we’ll explain in a moment, opens up the question of whether the new scheme is a CBDC as usually defined at all.

Some points are clear. China’s digital currency is being designed primarily for retail use, rather than wholesale and interbank transactions.

The basic structure will be two tier. The first tier involves the PBOC issuing CBDCs to commercial banks (and possibly non-bank financial firms). In the second tier, banks will then provide CBDC to consumers and non-financial firms through digital wallets. The simplest analogy is perhaps banknotes: they are provided by the central bank to commercial banks and then offered by commercial banks to customers, with ATMs standing in this analogy for digital wallets. People will add funds to their digital wallets by transferring from normal bank accounts.

The two-tier structure is reflected in how the PBOC refers to it: a Digital Currency / Electronic Payment (DC/EP) system. We prefer eCNY.

One virtue of the two-tier system is that account management and clearing functions sit with commercial banks and payment providers who are better qualified to perform them. The PBOC also apparently hopes to foster innovation. It may simply set standards and leave implementation of the second tier entirely to wallet providers.

The key point still unclear is the precise role that commercial banks play. Mu Changchun, the PBOC official overseeing the project says in this presentation (at 18’45’’) that consumers “will have a direct claim on the central bank”. The commercial banks that issue wallets would then solely be intermediaries providing a layer of service.

By contrast, Zhou Xiaochuan, who was PBOC governor when the eCNY project was launched and appears to still have an unofficial role as a spokesperson for the project, says that the contents of digital wallets would be liabilities of the wallet issuer, not the central bank (see, for example, this speech from late 2020, and this Caixin article from February 2021). In Zhou’s model, eCNY balances would be fully backed by assets held by the wallet issuer at the PBOC but not direct claims on the PBOC.

The rest of Mu’s presentation linked above actually tallies closely with the architecture Zhou presents in all other respects and is more internally consistent if Zhou is correct on this point.

In one sense, this difference is highly significant. If eCNY isn’t a claim on the central bank, it isn’t strictly a CBDC at all. In another, it doesn’t matter much. Claims on a commercial bank that are backed by ring-fenced assets at the central bank are scarcely less secure than direct claims on the central bank. (This is the model by which commercial banks in Hong Kong, Scotland and Northern Ireland are allowed to issue banknotes.)

Zhou presents his model as a way to avoid the threat of disintermediation: the contraction of bank balance sheets as customers shift deposits to the central bank.

In a true CBDC in which wallet contents are central bank liabilities, the transfer of funds from regular deposit accounts to eCNY wallets drains funds from the commercial banks. (See Table 1.) Commercial bank balance sheets contract as they lose both their reserve money asset and customer deposit liability in equal amounts.

For banking systems like China’s with few excess reserves, this contraction would force banks to curtail lending. Banking systems in most developed economies today are awash with excess reserves, but some individual banks may still be forced to seek new funding – they could raise deposit rates, offer longer term deposits, or tap wholesale markets. Any of these options could raise their cost of funding.

Most central banks that are considering CBDCs have suggested that ceilings might be placed on how much could be stored in a CBDC wallet to limit disintermediation. This isn’t without problems of its own though – what happens to transfers into a wallet that’s already reached the ceiling?

Zhou’s model, which the BIS calls a “synthetic CBDC”, deals with the threat of disintermediation by keeping eCNY balances on bank balance sheets. (See Table 1 again.) But this isn’t a complete solution. While the shift of customer deposits into eCNY wallets would not cause directly commercial bank balance sheets to contract, it would change their composition in a way that could affect their capacity to lend. Banks would swap existing reserves at the central bank for new CBDC deposits. Regular bank reserves can support a deposit base a multiple of their size. CBDC deposits must match eCNY deposits one-to-one: an effective required reserve ratio (RRR) of 100. So the net result would be the same: banks would have to curtail lending unless the PBOC offset the impact of transfers into eCNY wallets by lowering the RRR.

One area where the PBOC’s thinking appears to have shifted is on the use of a distributed ledger or blockchain. PBOC officials previously said that eCNY would involve a distributed ledger but more recently have said that the technology can’t support the volume of transactions needed.

Table 1: Simplified Balance Sheets (+ and - in brackets show change relative to traditional structure)

 

Central Bank

Commercial Banks

Household

 

Liabilities

Assets

Liabilities

Assets

Traditional

Reserve money

Currency in circulation

Reserves at CB

Cash in vault

Customer deposits

Bank deposit

Cash

CBDC

Reserve money (-)

Currency in circulation

CBDC (+)

[accounts held by public]

Reserves at CB (-)

Cash in vault

Customer deposits (-)

Bank deposit (-)

Cash

CBDC (+)

[claim on central bank]

“Synthetic” CBDC

Reserve money (-)

Currency in circulation

CBDC (+)

[accounts held by banks]

Reserves at CB (-)

Cash in vault

CBDC account at CB (+)

[claim on central bank]

Customer deposits (-)

Balances in “CBDC” wallets (+)

[accounts held by public]

Bank deposit (-)

Cash

Balances in “CBDC” wallets (+)

[claim on commercial bank]

Source: Capital Economics

When will eCNY launch?

The People’s Bank has been working on the digital currency since 2014. Mu, the PBOC official leading the project, said in 2019 that it was “ready to launch”. More recently, he has said that there is no timetable.

The PBOC has said on several occasions that it wants the digital currency to be available to participants and visitors to the Winter Olympics in February 2022. But that could simply be a restricted pilot project, testing the currency’s use by foreigners (a gold digital wallet for all athletes?). The PBOC has been running trials in cities across China since 2020: residents apply to a lottery to be issued with a small sum of digital cash via a smartphone app; it can be spent in designated retailers and online stores. By now a large number of people have participated. But the trials have all been time-limited – any unspent balances expired – and it’s not clear whether the “digital wallets” in these trials are stable pre-release versions of the finished product or early prototypes intended mainly to explore different use cases.

It is likely that the move from pilot stage to launch will happen incrementally, perhaps only in a few cities and with designated partners, before access is broadened. China’s government often adopts an incremental approach to new initiatives. For example, the use of renminbi (CNH) to settle cross-border trade was initially restricted to approved firms in a handful of mainland cities trading with partners in Hong Kong, Macao or ASEAN countries. Those restrictions were relaxed gradually over time. A gradual rollout of eCNY would allow the impact on behaviour and on banks to be closely monitored.

In other words, while launch of the CBDC has apparently been “imminent” for some time, it may still be on the runway in a couple of years’ time. The fact that few details of the eCNY architecture have been revealed might itself signal that key questions about its design have still not been resolved.

Why is the PBOC leading the way? 

That said, there is no doubt the PBOC has devoted more energy to its CBDC project than other major central banks.

The PBOC initially considered a CBDC in the context of a bitcoin boom in China in 2013, and concerns that adoption of cryptocurrencies might limit its control of domestic financial conditions. (In the end, regulators simply banned cryptocurrency exchanges.) Since then, the PBOC has on occasion suggested that a CBDC could aid financial inclusion, raise the efficiency of the payments system, and help it tackle money laundering.

But the key reason China is taking a lead is that mobile payment (i.e using a phone or computer rather than card or cash) has become far more common in China than in most places. (Sweden’s Riksbank is another forerunner for the same reason.)

Overwhelmingly in China, those payments go through either Alipay or Tenpay (the umbrella firm for WeChat Pay and its smaller sibling Mobile QQ Wallet). The Alipay and WeChat Pay duopoly processes 94% of third-party mobile payments. (See Chart 5.)

In turn, Alipay and WeChat Pay underpin twin ecosystems of services spanning shopping, food delivery, ride hailing, healthcare, insurance and wealth management. Many businesses are entirely dependent on Alipay or WeChat Pay for revenue. That has made the two private online payments providers systemically essential to the economy to a degree that policymakers could not ignore.

Chart 5: Mobile Payment Transactions By Third-Party Providers (% of total, 2019)

Source: iResearch.com

Mobile payment apps were originally mainly used in China for online purchases. But since 2017 they have become dominant offline too. Three quarters of transactions processed by non-bank payment services are now in-person. Mobile payment has largely supplanted cash. Debit cards are common – according to the PBOC there are 8bn in circulation. But in 2019, two thirds of day-to-day personal spending went via mobile payment.

Many central banks have said that their interest in CBDCs stems from their responsibility to provide a resilient, universally-accepted public payment system as cash falls out of daily use. So the PBOC is not alone. But that transition to mobile payment is further advanced in China.

On top of that, China’s leadership is not comfortable allowing private actors to hold significant power in any sphere in China. It has launched a broad crackdown on the tech giants – China’s most successful private firms. The CBDC project was already well advanced when the crackdown began in 2020. But it is entirely consistent with the goal of reining in their economic power and ensuring that the state reasserts dominance in this rapidly expanding area too.

There may be other motivations for the PBOC, but they are secondary. Payments through a CBDC could be monitored more easily. Management of cross-border payments may be simpler. But the PBOC can already monitor all non-cash transactions now since both bank and non-bank transaction each go through central clearing houses. A CBDC might make surveillance easier, but it wouldn’t give officials powers they don’t have already.

Will eCNY succeed?

The trials that have been run so far appear to have been successful, in that the lotteries held to choose participants have been oversubscribed and the eCNY wallets appear to have functioned as intended. It is less clear whether eCNY will be adopted by the public if it’s not gifted to them.

We suggested above that a lack of clear benefits to consumers will be the key constraint on the expansion of CBDCs in most economies. It’s even harder to identify what those benefits might be in China, where the Alipay/WeChat Pay duopoly already provides a reliable digital payments system that has been widely adopted by consumers and firms. Most people have accounts with both.

Going back to the supposed benefits of CBDCs over private digital payments, from the perspective of consumers these are:

  • Greater security (savings aren’t held by a private firm)
  • Anonymity
  • Accessibility (e.g may not require a bank account or a mobile data connection)

The security point is surely moot: few people in China believe that their savings are at risk – whether in mobile payment wallets or the linked bank account (all wallet funds are already required to be held in escrow at banks).

As for anonymity, a new system may shield more of a user’s information from banks or payment provider. But the PBOC will still have oversight. (Mu has suggested that small transaction up to a limit might be anonymous – similar to using cash today).

That leaves accessibility as an advantage over the established players. For many low income economies, financial inclusion is the key attraction of CBDCs: a wallet can be installed on a phone without any need to visit a bank. This shouldn’t be dismissed as an advantage for China. Although digital payment is ubiquitous, 10% of adults didn’t have a bank account in 2019 (17% in rural areas), which meant they couldn’t use Alipay or WeChat Pay. According to a World Bank survey from 2017, 82% of those without a bank account had a mobile phone. However, the main reason given for not having an account was a lack of funds: expanding mobile payments access to this non-banked section of the population may be worthwhile, but they don’t have the spending power to elevate national use of eCNY.

The benefits of being able to use eCNY offline are similarly limited. Alipay and WeChat Pay can be used offline in certain circumstances, but need a regular connection. The PBOC has long touted offline payment (most likely using a phone’s NFC function) as a key feature of its CBDC so it is possible that eCNY’s architecture will allow users to go longer without a data connection than they can today. Again, though, the number of potential users who spend lots of time in areas with poor mobile reception is probably low, and their spending power is most likely low too.

The other important players are the banks and existing mobile payment providers. For banks, as discussed above, the movement of deposits into eCNY wallets either raises funding costs (true CBDC) or raises the effective reserve requirement (synthetic CBDC). For Alipay and WeChat Pay, widespread adoption of eCNY in place of their own payments system would deprive them of transaction fees and the information they currently harvest on consumer behaviour.

In sum, eCNY isn’t an improvement over existing payment options for the vast majority of consumers and is worse from the perspective of banks and today’s mobile payments providers. Left to the market, eCNY is unlikely to succeed.

But the government doesn’t have to leave it to the market. The PBOC says that eCNY will coexist alongside other payments systems but that all businesses that accept any form of digital payment must accept eCNY (it’s legal tender after all). Alipay and WeChat Pay will therefore have to include an eCNY payment option.

The PBOC says that it won’t offer interest on eCNY balances, removing the potential to offer this as an inducement. But the government could ensure that wages of public sector (and state sector) workers, plus pensions and transfers are paid into eCNY accounts and require that fees and taxes are paid in eCNY. And it could go further and require payments providers to make eCNY the default payment option.

We think this is what will ultimately happen. It will probably not happen for a few years – a slow pace of adoption may initially suit officials wanting reassurance that eCNY is not destabilising banks and wanting to give the payment system time to mature. But if the goal of the eCNY project is to re-establish state control over the payment system, the implication is that the government will in the end ensure that eCNY supplants private payment providers.

What are the implications for domestic policy?

New payments architectures usually don’t generate the buzz that has been emanating from CBDCs. Much of the interest stems from the idea that CBDCs will open up new policy options or reshape the global financial system.

Domestically, CBDCs create new options, at least in principle, for both monetary and fiscal policy. (We consider the international dimension in the next section.)

On the monetary side, several central bank research departments have considered the implications of paying interest on CBDC balances and using it as a policy instrument. The People’s Bank though has said that interest (positive or negative) will not be paid on CBDC balances. (Most other central banks currently seem to be leaning the same way.)

The replacement of physical cash with digital cash could affect policy even if interest weren’t paid: as long as the option to hold cash exists, there’s a limit to how negative rates can go. If cash is phased out, that constraint vanishes. Caps could be placed on balances in CBDC accounts so they couldn’t be used to evade negative rates on regular bank accounts.

In practice though, cash will be around for the foreseeable future. And, in China at least, policy rates are still well above zero – the zero bound is not a constraint on lowering rates if needed.

As for fiscal policy, transfers of money would be much easier to implement if each resident had an eCNY account. US stimulus cheques illustrate that new technology isn’t needed to achieve the same end though it illustrated the difficulty in reaching those without bank accounts. In China’s case, the government shows little enthusiasm for stimulus through handouts to households. Stimulus has hitherto always involved credit-fuelled investment. But the finance ministry’s priorities may change in future. The government could go further – eCNY accounts would also facilitate helicopter drops (i.e. fiscal transfers without any offsetting increase in government debt).

The more interesting policy innovations made possible by CBDCs take advantage of their “programmable” aspect. Whereas, today’s digital money is a fungible entry on an electronic balance sheet, deposits in eCNY wallets could have built-in conditions on their use (“smart contracts”), making them non-fungible. Fiscal handouts could have conditions attached that limited what they could be spent on, where they could be spent, or set a deadline at which they expired. (Vouchers and stored value cards achieve the same today, but less efficiently.) Tax payments could be automated as transactions occur. Transfers could be targeted to specific type of account holder. In a similar vein, the PBOC’s targeted lending programmes could be made more precise. These are designed to incentivise lending to favoured classes of firm, such as small and micro-enterprises, that otherwise struggle to get credit. This wouldn’t be a gamechanger – the programmes already exist after all. But it may be easier to ensure that eCNY funding reaches the intended recipient.

These are design choices though, not something that is inherent in all types of CBDC. And they come with trade-offs: putting limits on how a CBDC balance can be used raises the possibility than it could trade at a discount to “true” legal tender, something the central bank would want to avoid. The People’s Bank has not talked about these capabilities much which suggests that they won’t be built into eCNY1.0.

Could eCNY challenge the dollar?

The most fanciful commentary around China’s CBDC suggests that eCNY could propel the renminbi to becoming a rival for the dollar globally, for example by taking a “first-mover advantage” in the international marketplace for CBDCs.

China is several years from having eCNY widely accessible outside China, which is surely a pre-requisite for it to be in widespread use. We argued above that pilot schemes and trials will continue domestically for another couple of years before eCNY is widely available inside China. Abroad, China can’t roll out a new payments network unilaterally. It will need the cooperation of foreign firms and regulators to facilitate transfers. It is now possible to use foreign credit cards with Alipay and WeChat Pay, but it has taken several years to get to this point. And eCNY wallet issuers will need a means to verify foreign account holders’ identity so that accounts can’t be used for money laundering or evading capital controls.

Once eCNY wallets are available to foreigners, the next needed step is for foreigners to want to use them. Much as eCNY doesn’t solve any major problem for Chinese consumers, it doesn’t for foreign trade or investment either. In normal times, trade finance works well, and transacting through the large, liquid dollar market is cheap. Just as users of CNH are still subject to capital controls, the same would be true of foreign users of the digital version. And the PBOC cannot compel foreigners, unlike Chinese residents, to use its digital currency.

Chart 6: Share of China's Goods Trade Settled in CNH (%)

Sources: CEIC, Capital Economics

Meanwhile, none of the structural forces that have held back the renminbi’s adoption abroad would be addressed by the introduction of eCNY. China has been the world’s largest trading nation since 2010, and it has been possible to settle trade in CNH since then too. Yet today, only 16% of China’s own goods trade is settled in renminbi. (See Chart 6.) That share has halved since 2015. Use of CNH to settle trade between other countries is negligible. According to SWIFT, only 2% of global transactions in March were in CNH. The renminbi plays a similarly small role in the foreign exchange market (around 2% of spot transactions) and as a reserve asset (around 2% of central bank foreign exchange reserves).

One reason CNH has failed to take off is that network effects are powerful. The depth and liquidity of the dollar markets makes it cheaper to transact through them. The more participants there are, the less reason there is for anyone to go elsewhere. When CNH was first launched, many argued that its use would rise along with China’s weight in global trade. But apart from during the pandemic, China’s share of global trade has not risen over recent years. Nor have its exports or imports relative to global GDP. (See Chart 7.) The launch of a digital version of CNH wouldn’t change any of this.

Chart 7: China's Goods Trade (% of Global GDP)

Sources: CEIC, Capital Economics

A more intriguing possibility is that the unique features of a CBDC might eventually allow eCNY to be adopted in entirely new areas where CNH currently isn’t available. For example, if eCNY wallets were widespread, they would provide a readymade mobile payments system for any country willing to allow their use for domestic transactions. That would boost financial inclusion – according to the World Bank, two thirds of adults in low income countries didn’t have bank accounts in 2017.

Note though that the Bahamas has already launched its own CBDC in order to raise financial inclusion across the country’s many islands, which suggests that even small EMs won’t need to piggyback off CBDCs developed elsewhere. (There are other solutions too: in Kenya, 72% of people have a mobile payment account delivered by a mobile phone service provider.) And widespread adoption of a foreign currency (“dollarization”) is generally something that policymakers want to avoid because it undermines the effectiveness of monetary policy.

That said, dollarization is quite common in emerging economies. A 2020 IMF study found that more than half of deposits were foreign-currency-denominated in 26 of 154 countries examined (17% of them). Typically, dollarization is a response to high inflation or exchange rate volatility. CBDC digital wallets, if allowed by governments (as foreign currency bank accounts are) would make the adoption of a foreign currency much easier – every smartphone owner could have a wallet overnight.

However, there is a second constraint on global adoption of the renminbi in that it requires foreigners to be willing and able to build up large claims on domestic Chinese financial assets. China’s financial markets have long been opaque, regulation weak and legal protection arbitrary. Capital controls remain and currently permissible channels through them could be closed in times of market stress.

Admittedly, many longstanding foreign investor concerns have been addressed and officials appear keen to go further. But there is a fundamental tension: the renminbi would only have a hope of rivalling the dollar globally if China’s financial markets were as open to foreigners as those in the US. That would require capital controls to be abandoned, which in turn would make it no longer possible to manage the exchange rate. It would probably also require China to run a current account deficit: as long as surpluses persist, China is in aggregate adding to its net foreign assets.

Many who are bullish on internationalisation of the renminbi implicitly assume that China’s leadership will make these changes in order to elevate the renminbi’s global role. But looking at the broader context of official priorities that’s highly unlikely. Opening the capital account and relaxing control of the exchange rate would put the domestic financial system under huge strain, which is why the People’s Bank has pledged since the 1990s to open the capital account but never quite got there.

None of this is changed by the introduction of a digital renminbi. And there is no first mover advantage. eCNY would be competing, not with the eUSD or eEUR of the future but with the well-established dollar and euro-denominated capital markets of today.

Putting in a modern payments system is like up-grading the plumbing. The efficiency of circulation might improve. But it doesn’t affect the pressure which is what determines where money flows.

eCNY and decoupling

Just as eCNY wouldn’t transform the renminbi’s use globally, it wouldn’t dramatically improve China’s capacity to withstand financial decoupling. But it might make a difference in a crisis.

The global financial crisis was a wake-up call for China’s leadership as to how dependent China was on the US financial system to underpin trade. The first limited trials of CNH-settled trade began in December 2008 amid concern that the dollar-based system of trade credit was breaking down. Since then, the US has established a practice of using its control of international clearing to pursue political ends. China’s Bank of Kunlun was cut off from the US financial system in 2012 for providing funding to Iranian banks. More recently, US banks have been instructed not to do business with several Chinese firms and individuals connected with repression in Xinjiang and Hong Kong.

CNH already provides a backup means of transacting without the involvement of any US institutions. In principle, eCNY should be an improvement in that it would be more efficient and easier to maintain and expand access during a crisis. There is a parallel here with the domestic picture. Just as the key motivation for the rollout of eCNY domestically is to reassert government control over the payments system, a key advantage of eCNY’s availability abroad would be that it gave China an international payments system that it controlled.

But the resilience eCNY and CNH would provide should not be overdone. They enable China to shield financial and trade flows from direct involvement by US firms. But the US still has considerable leverage through its ability to sanction any non-US firms that got involved. When forced to choose between access to the US financial system or the Chinese one, banks in most countries would opt for the former. In other words, even with eCNY, the US would have the ability to inflict huge damage on China’s trade and other cross-border flows by imposing financial sanctions. At most, eCNY would provide a lifeline to allow some transactions to continue.


Mark Williams, Chief Asia Economist, mark.williams@capitaleconomics.com

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