THE ROLE OF DIGITAL YUAN IN CURRENCY INTERNATIONALIZATION

Read Part 1 , Part 2 and Part 3 here

Despite China’s rapid economic growth and rising economic clout in the past four decades, it still lags behind the US economy by a significant margin. It is evident from multiple factors like the share in global payments where Chinese Yuan ranks fourth with a contribution of about 5 percent, which is considerably behind the US’s 47 percent share. Similarly, Yuan covers only 2.37 percent of global foreign exchange reserves, as opposed to nearly 60 percent contributed by US Dollars. As a result, China along with the rest of the world still relies heavily on the Dollar system which could prove to be a major vulnerability for China in the event of US-China trade war escalation or even due to potential economic sanctions during China-Taiwan conflict. Thus, China has been promoting the role of Yuan in global financial system to avoid this vulnerability in the last few years. In case of Digital Yuan, from leading the development globally to promoting it in cross-border payments, China’s intentions to leverage benefits of Digital Yuan to internationalize its currency are quite evident. However, owing to the meagre success of Digital Yuan pilots domestically and other inherent challenges, doubts are being raised about the effectiveness of Digital Yuan in the process of RMB internationalization. Hence, it is important to analyse different ways adopted by China to promote Digital Yuan globally and how it will shape Yuan’s role in the global economy.  

Pilot efforts to attract foreign users

China began testing the utility of Digital Yuan in cross-border payments with its pilot launch in Hong Kong in late 2020. It was also linked to Hong Kong’s Fast Payment System (FPS) to enable both individuals and businesses to seamlessly transact between Yuan and Hong Kong Dollar. However, it may not accurately reflect the success of Digital Yuan in cross-border payments owing to Chinese control over Hong Kong economy. Ultimately, the success of Digital Yuan will depend on its acceptance by foreign governments and even foreign nationals visiting China or making offshore transactions in Yuan. In this regard, China introduced Digital Yuan for the first time for foreign visitors during Beijing Winter Olympics in 2021 which witnessed over 2 million Yuan ($0.3 million) worth of daily transactions. This pilot was replicated during World University Games in Chengdu and Asian Games in Hangzhou last year where over 300 million Yuan were spent in Digital Yuan.

Similarly, Digital Yuan was piloted at the 2021 China International Import Expo which saw participation of over 3000 companies as well as at the 2023 Beijing service trade fair where it aimed to introduce Digital Yuan in supply chain financing. One of the important features of these pilots has been the inclusion of private payment aggregators like JD Technology and Alipay as well as businesses like Pizza Hut and KFC which offered discounts on the usage of Digital Yuan. This, in some way, demonstrates the acceptance of Digital Yuan beyond state-owned companies and attempts to make it more attractive for foreign consumers. Moreover, Digital Yuan was recently used for cross-border commodities trade like gold and iron worth millions of Yuan. More importantly, Digital Yuan was also used in trade of nearly 1 million barrels of crude oil, demonstrating Xi’s resolve to use Yuan for oil trade settlements. However, all these efforts will only have limited success due to the circumstantial and event-specific nature of these pilots. Despite creating short term attraction for Digital Yuan, these pilots will not succeed in converting it into persistent demand.

Gaining acceptance through Institutionalization

Along with event-specific pilots, China has simultaneously focused on incorporating institutional framework – both bilateral and multilateral - into the global rollout and adoption of Digital Yuan. One of the foremost attempts in this direction has been the creation of Multiple Central Bank Digital Currency (CBDC) Bridge or mBridge project with the help of the Bank for International Settlements. This project involves China’s Digital Currency Institute, Hong Kong Monetary Authority along with central banks of UAE and Thailand. This project aims to create a secured environment for experimenting applications of digital currencies for cross-border payments. Under this project, Digital Yuan emerged as the most widely used CBDC with transactions worth $1.6 million during a six-week pilot period. The continued success of this initiative will help China to promote its CBDC at the global level as it will create a more conducive environment for its wider acceptance.

Similarly, China has also been promoting Digital Yuan among its regional trade partners, especially with ASEAN countries. Recently, Guangxi adopted Digital Yuan in its dealings with ASEAN countries such as the China-ASEAN expo, ASEAN free trade zones as well as in border trade. With ASEAN being the largest trading partner of China, China can accrue more legitimacy for its CBDC by promoting Digital Yuan among its most trusted partners. Regionalisation of Digital Yuan through such measures is also being promoted at bilateral levels such as with Singapore where Chinese tourists will be able to use Digital Yuan on a pilot basis. In addition, with the launch of Regional Comprehensive Economic Partnership, it will be much easier for China to position Digital Yuan as a preferred payment mode.

The Belt and Road Initiative (BRI) also provides a critical institutional platform for China to push for the internationalization of Digital Yuan against the Dollar. Along with its use in settling payments and granting RMB denominated loans, China may also transfer CBDC related technology to BRI countries under its Digital Silk Road and further push these countries away from the Dollar system. In fact, Bank of China and UAE’s First Abu Dhabi Bank recently signed an agreement to promote Digital Yuan among UAE businesses dealing with China as well as for Chinese nationals operating in UAE. It will not be surprising if more BRI countries sign similar agreements in the future given their economic dependence on China. Moreover, Xuzhou in Jiangsu province recently began to use Digital Yuan for payments of several services offered under China-Europe freight trains which is a one of the flagship BRI projects. Such actions are in contradiction with former People’s Bank of China (PBoC) Governor Yi Gang’s statement in 2021 about not promoting Digital Yuan through BRI and thus, creates suspicion about China’s true motivations vis-à-vis internationalizing Digital Yuan.

Only a small step towards internationalization

Despite promotion through different channels, China’s Yuan internationalization efforts are already plagued with several challenges such as lack of full capital account convertibility; marginal share in global forex reserves and cross border payments; lack of credibility for China’s financing methods; lesser liquidity compared to Dollars and so on. While Digital Yuan promises to be a solution for few of these problems, it is also not free of headwinds. Limited success in domestic markets and lack of credibility due to data privacy concerns are major impediments for Digital Yuan being promoted globally. Similarly, government - or more precisely - Party control over PBoC (which is the primary player in Digital Yuan initiative), may discourage potential users as it causes lack of transparency on the regulatory side. The independence of markets in the USA has been one of the major reasons for the success of Dollar in becoming a global currency. Digital Yuan will face a major challenge in this regard due to restrictive Chinese markets. The global rollout of Digital Yuan will also depend on the technological progress made by other countries with regards to CBDCs. This will not only help to favourably change people’s perception about CBDCs but also equip countries to resolve any unforeseen issues in this nascent technology. Furthermore, to what extent will Digital Yuan be able to maintain their primacy when other major countries begin rolling out their CBDCs, is something that needs to be seen in the next few years.

On the other hand,  willingness and capacity for de-Dollarization has been growing globally in the past few years with countries like Russia, Saudi Arabia, Argentina, etc. preferring to settle trade payments in either local currencies or in Yuan. However, these payment volumes are negligible compared to that in Dollars. Nonetheless, given China’s past practices of trade weaponization, China may further increase demand for Yuan or even Digital Yuan in the short run by exploiting trade vulnerabilities of several countries. However, to sustain this demand in the long run, China needs to popularize an alternative framework to the Dollar system such as Cross-border Interbank Payment System (CIPS) started by PBoC in 2015 and integrate Digital Yuan into it along with structures like mCBDC which will require widespread participation from other countries. If China succeeds in this, it might be able to create a stronger alternative clearing system to The Society for Worldwide Interbank Financial Telecommunication (SWIFT), in which central banks of different countries will be able to settle payments directly in CBDCs and thereby, reduce Dollar dependence. As Digital Yuan is substantially ahead of other CBDCs, China can leverage this headway to create more demand for Digital Yuan. However, monetary regulatory framework in all countries have to be aligned for Digital Yuan to function smoothly in cross-border transactions.

Thus, looking at the current scenario, Digital Yuan has a long way to go before it could aid in China’s currency internationalization. Event-specific efforts to popularize Digital Yuan will only result in short term demand while China needs to build an alternative institutional framework through which Digital Yuan can be utilized in cross-border payments. Although China has succeeded in surpassing Dollar with Yuan in its own global transactions, the US Dollar’s global dominance is still unshakeable as most countries still find it most feasible as well as difficult to break away from the Dollar-based global financial system. The internationalization of Yuan has been a long-cherished dream for China as it serves its global ambitions and Digital Yuan, although seemingly an attractive bait, is only a small step in fulfilling that dream.