IMPLICATIONS OF DIGITAL YUAN FOR CHINESE ECONOMY

Read Part 1 and Part 2 

Since the pilot launch of Digital Yuan in China, there have been several debates about its potential implications for the domestic economy. Although it is expected to increase economic inclusiveness in China, concerns about its impact on existing payment systems as well as on users’ data protection are still not clear. Digital Yuan is being designed in a manner which can eliminate problems of other popular payment systems. Similarly, commercial banks have been the major financial intermediaries between the regulatory authorities and citizens until now. However, with the promotion of Digital Yuan, the role of banks in China’s financial systems will also undergo significant changes. Extensive pilot trials across provinces and scenarios in the last three years have revealed several potential impacts on its domestic economy. Amidst the slowdown in China’s economic growth since the COVID-19 pandemic, it is important to analyse how the push for Digital Yuan will impact China’s overall monetary policy implementation as well as on consumer behaviour.

Impact on China’s Monetary Policy Transmission

During the initial development stages of Digital Yuan, many doubts were raised regarding its impact on paper currency. People’s Bank of China (PBoC), in its white paper, has clarified that it will continue to issue paper currency as long as there is a demand for cash. Nevertheless, a study suggests that use of paper currency is expected to reduce significantly in coming years due to higher rate of substitution from paper to digital currency and traditional currency will remain limited to few sections of the society like elderly people. Furthermore, several pilots over the last three years have revealed that formulation of different tiers for the usage of Digital Yuan will ensure that no additional pressure is created on the present monetary and banking system in times of crises. Despite this, Digital Yuan still forms only 0.16 percent of M0 circulation after its inclusion in the formal currency system in December 2022, while the rest accounting for physical currency in circulation. Thus, the elimination of paper currency due to Digital Yuan’s popularity seems to be a distant reality in the present situation.

PBoC – as the primary distributor of Digital Yuan – will be in a better position to control any potential bank runs or other banking risks in case of disruptions. During 2023 state council reforms, several functions of PBoC were cut down which allowed it to focus more on monetary policy implementation and its faster transmission through newly formed provincial branches. Moreover, Digital Yuan will provide more real time information about economic activities as this system will be managed centrally. Thus, increased distribution of Digital Yuan coupled with creation of new provincial branches will help PBoC to address liquidity crises at local level more effectively. Despite this extensive control by PBoC, the role of commercial banks - included in tier 2.0 and tier 2.5 of Digital Yuan ecosystem - will not entirely diminish as these institutions would still be nodal points for retail consumers. Thus, PBoC would have to rely on networks and trust built by these institutions over the years to popularize the use of Digital Yuan.

Lastly, Digital Yuan can also help the government in nudging citizens to consume certain goods and services as PBoC will be able to issue customized currency with certain conditionalities. For instance, issuance of red envelopes of Digital Yuan during festivals or special issuance during Beijing Winter Olympics have enabled PBoC to target specific occasions as well as specific audiences. This practice can prove beneficial for China in attracting consumption in low-performing sectors and in accordance with Xi's focus on boosting domestic demand to spur economic growth. Moreover, as PBoC is expected to track all large transactions of Digital Yuan in real time, it can keep a check on illicit transactions and avoid financial frauds like money laundering, funds misappropriation and so on. However, people involved in such transactions would still prefer using paper currency, thus reducing the effectiveness of Digital Yuan.

Extent of Popularity of Digital Yuan

Introduction of the Digital Yuan will help in the financial inclusion of unbanked people as well as people with poor connectivity infrastructure. This section of population can avail several financial services through Digital Yuan such as subsidized loans and other poverty alleviation schemes without local intermediaries. However, there are several challenges like concerns about security and utility of Digital Yuan which will persist in rural areas as current pilots are mostly limited to only urban areas. Moreover, China needs to build a robust infrastructure for this which can effectively prevent cyber-attacks and thereby, avoid panic in the economy. Such challenges are critical in determining the extent of financial inclusion achieved by the launch of Digital Yuan.

Nonetheless, Digital Yuan showed some acceptance in pilot areas during festive seasons when overall consumption had surged. During the 2023 spring festival holiday, Meituan alone witnessed a rise of 400 percent in Digital Yuan transaction orders compared to 2022. Consumers across 17 pilot provinces spent millions of Yuan at over 90 merchant platforms covering over 20,000 merchant businesses. During this period, Shenzhen distributed over 100 million Yuan (15 million USD) of Digital Yuan envelopes to revive its catering industry hit by the pandemic. Moreover, besides its introduction in tourism, healthcare and education sectors, application of Digital Yuan is also being expanded to other services like paying salaries, taxes, loans, financial products like insurance. However, it is still unclear if people would adopt it in daily transactions or not beyond festive seasons. Few months ago, a former PBoC official Xie Ping had expressed dissatisfaction over the insufficient extent of the application base and usage of Digital Yuan. Concerns about Digital Yuan being another surveillance tool for the government along with popularity of existing digital modes have both limited the popularity of Digital Yuan. Thus, despite China’s efforts to fundamentally transform the payment system through Digital Yuan, there is still a long way to go due to multiple headwinds.

Future of Financial Intermediaries

Breaking the duopoly of Alipay and WeChat Pay in China’s payment systems has been one of the objectives of the Digital Yuan initiative. With regards to mobile payments, Alipay and WeChat Pay have substantial control over transactions data along with commercial banks and PBoC only acts as a regulator. On the contrary, PBoC will become a primary player in terms of control over the Digital Yuan system and financial companies like Alipay and WeChat Pay will act as service providers. As a result, these private platforms will lose flexibility in terms of data access, transactions details as PBoC will directly monitor all transactions in real time.

This transition from private companies to PBoC has led to concerns that it may significantly reduce the dominance of these companies which was also attempted to achieve through crackdown on these companies until recently. However, in the last one year, Li Qiang and other Chinese leaders have repeatedly called for an end to crackdown owing to the critical role these platform companies play in spurring economic growth and creating jobs. Moreover, it is worth noting that Alipay and WeChat Pay have both been included in pilot projects of Digital Yuan along with government banks, owing to their huge customer base in China. Further, most sellers in China have already set up a payment system that involves either of these mobile payment companies. Thus, efforts are being undertaken to improve interoperability of mobile payment platforms by integrating QR codes for Digital Yuan in existing systems to expand the utility of Digital Yuan across all retail scenarios. Hence, the success of Digital Yuan will largely depend on support provided by these companies and thus, they will play a dual role of both competitors as well as partners in the development of Digital Yuan.

Conclusion

Digital Yuan promises to offer several advantages like convenience, greater accessibility and prevention of financial frauds, albeit the lack of clarity about its implications for data privacy still looms large. Although laws like the Personal Information Protection Law passed in 2021 guarantees strict regulations for online data management, fears remain about whether Digital Yuan will be integrated into China’s holistic surveillance system and thus, become another tool for the government to control citizens’ lives. These fears, coupled with people’s preference for mobile payments have still limited the success of Digital Yuan as the government would have anticipated. The Chinese government has to undertake significant efforts to attract people to adopt Digital Yuan as their primary payment mode and it might take several years before it achieves its objectives of financial inclusion and establishing state control over financial data. Beyond these domestic implications, China has also planned to include Digital Yuan in cross-border payments and use it as a potential tool for internationalizing its currency. This is poised to have significant implications for the global financial system which will be covered in the next part of the series.