China’s rapid push to issue a digital currency could go a long way toward expanding the country’s digital economy, and by making transactions easier, help bring as much as a fifth of the population that remains unbanked into the formal economy.
The government is moving rapidly into the e-payments space currently dominated by private players such as Tencent and Alibaba, with its digital currency electronic payment (DCEP) system, an electronic version of the country’s currency, the yuan. Its efforts may give China a leading position in developing a national digital currency and drive the evolution of the digital economy and the global influence of the yuan.
Financial inclusion
‘The development of the digital yuan will mean China’s central bank can have a greater foothold in, and therefore control of, China’s digital payments ecosystem,’ says Hampton Group CEO Andrew Methven. Hampton Group provides insights and advice on China issues, stakeholder engagement and cross-cultural communication.
Developing its digital currency would allow China to bring some of its unbanked population into the mainstream economy, track money flows better and fight financial crime, Methven adds.
It should also help make payment transactions more ‘efficient, timely, almost costless’ and promote financial inclusion, says Hung Tran of US thinktank the Atlantic Council and an expert in financial regulation and fiscal and structural reform.
‘Digital renminbi will help companies, especially small and medium-sized enterprises, receive financing’
Crossborder payments will also be made easier once the digital currency is made available outside of China. And because it will remain under central bank control, it could make the yuan more influential. This is particularly true in light of China’s push to expand the Belt and Road initiative in the Middle East and Africa, which creates more markets with potential to use the digital currency in trade settlements. Still, it is unlikely to give the yuan a significant push towards more widespread use as a reserve currency.
‘To be used as a reserve currency, renminbi – both in digital and bank balance forms – needs the support of well-developed financial markets with sufficient sophistication and liquidity under competent regulations, including being fully convertible,’ Tran says.
Methven shares this view. ‘Internationally, I think it’s unlikely the development of digital renminbi alone will lead to renminbi becoming a dominant reserve currency – certainly not in the short term,’ he says. ‘But it will give China more weight internationally as a global leader in technology innovation, particularly fintech and digital currency.’
Timely support
Chinese companies and the fintech sector are likely to be early beneficiaries.
‘Digital renminbi will help companies, especially small and medium-sized enterprises, receive financing easier, as banks could have a better knowledge of how companies will use loans, which helps reduce financial risks,’ says G Bin Zhao, a senior economist at PwC China.
‘The fintech industry will take a big step forward with digital renminbi’
Digital rollout
The use and spread of a digital version of the yuan should strengthen governance and give China’s digital economy another leg up, but it is unlikely to change the way companies do their accounting and reporting.
‘The rollout of a digital yuan will not change accounting standards in the short term,’ says PwC China senior economist G Bin Zhao. ‘But this will make it difficult to conduct financial fraud – in the future when the digital yuan is widely accepted – in terms of accounting due to the traceability of a digital currency.’
As it develops its digital currency, China could find some advantages in its capacity to move quickly with new projects.
Gary Schwarz, professor of public policy and management at SOAS University of London, is optimistic about the comparatively rapid introduction of the digital yuan.
‘It will take the European Central Bank years to coordinate all the views of the EU member states and deal with the associated privacy issues,’ Schwarz says. ‘Introducing its digital currency quickly will give China a competitive advantage in the international market.’
He adds: ‘Digital renminbi digitises all aspects of the yuan, including issuance, circulation, storage, and maybe also investment and crossborder flows in the long term, which provide an infrastructure for fintech firms to process data by using technologies including big data, blockchain and artificial intelligence, among others. The fintech industry will take a big step forward with digital renminbi.’
And the timing is good. China is rolling out its digital currency at a time when its digital economy is growing fast. According to Zhao, the digital economy accounted for more than 30% of China’s GDP in 2020 and could take up a full half by 2030.
Issued by the central bank, the digital currency will be the ‘cash’ inside digital wallets provided by the big online payment providers, Methven says. The digital currency will work alongside and in coordination with the traditional system.
‘I would expect there to be a healthy interplay between private sector innovators (providers of e-wallets) and the central bank (issuer of digital money) as things develop,’ Methven adds.
Early days
The digital yuan is still in its infancy. The central bank started working on the project in 2014, launching a pilot project in four cities – Shenzhen, Suzhou, Chengdu and Xiong’an in April 2020 and expanding it to 28 cities in August 2020. The plan is for broad circulation by 2022.
Most recently, the Hong Kong Monetary Authority started discussions with the People’s Bank of China to expand a crossborder test, and PBOC may work towards its use by foreign athletes and visitors during the Beijing Winter Olympics in 2022, according to the central bank deputy governor Li Bo.
One challenge that will have to be addressed is the extent to which foreign entities will be willing to use the digital yuan. A point of contention is likely to be the fact that the blockchain infrastructure of the digital currency would allow Chinese authorities to easily monitor transactions.
A second challenge will be the ongoing need for ‘more progress in developing China’s financial markets, and removal of capital controls including full convertibility of the yuan,’ Tran says.
A third challenge, Methven says, is that PBOC is a latecomer to the digital payments space, where incumbents are already well established. ‘China’s central bank will have to move very quickly to keep up, innovate and build a system that integrates with and improves what is already available from a user interface point of view,’ Methven explains.
Finally, rolling out a new digital currency on a country-wide scale is a huge undertaking.
Test and trial
Globally, a digital yuan will face competition from the cryptocurrency ecosystem and similar efforts in other countries.
‘China leading the way in developing its digital currency may lead to great competition from other central banks,’ Methven warns.
As it moves towards widespread implementation, PBOC will likely test its digital currency more widely and aim to replicate real-life situations, Tran says. For example, the digital yuan may be tested for paying salaries to selected groups of government employees and for paying government fees and taxes.
‘It will probably take time for PBOC to ascertain citizens’ preferences for the digital yuan relative to other forms of payments as well as testing all the technical features before deciding to officially launch it,’ Tran says.
‘I would expect to see different concepts and innovations trialled in different cities – it will be interesting to look out for which pilots gain traction and attention,’ Methven says. ‘Those that do are likely to become examples for future policies.’
