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China's understated moves on e-CNY belies its potential sway

Tang Weng Fai
Tang Weng Fai12/19/2021 09:39 PM GMT+08  • 6 min read
China's understated moves on e-CNY belies its potential sway
With China’s share of global trade and power of its banks, CIPS stands a chance of becoming a viable alternative to SWIFT
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It’s getting harder to ignore digital currency these days with the flood of news on the topic.

Amid the noise, a little something called central bank digital currencies (CBDC) has crept into the public eye, but not much is known about its connections with other parts of the payments landscape, especially the link with a larger trade-related ecosystem China is trying to cultivate.

The understated moves of China, in particular, has gotten fewer column inches than equivalent noise about the trading frenzy in bitcoin and linked issues.

What does CBDC’s have to do with trade and settlement? And why does China seem so keen to introduce CBDCs when others are (so far) only dipping their toes into the game?

Domestic pressures

Domestically, central banks are worried that the rise of privately-issued digital currencies will undermine the policy effectiveness of traditional instruments like the ability to control money supply, and set interest rates to conduct monetary policy.

See also: Southeast Asia's internet economy to reach US$1 tril by 2030: Google, Bain & Temasek report

China’s stance on the risks of private cryptocurrency has been unequivocal. In July 2021, the Peoples Bank of China (PBOC) issued a white paper which singles out the risks of privately-issued cryptocurrency as a systemic risk to China’s financial system:

“ … given their lack of intrinsic value, acute price fluctuations, low trading efficiencies and huge energy consumption, they can hardly serve as currencies used in daily economic activities”

Since the white paper, China has intensified crackdowns on domestic mining and the use of cryptocurrency. The signal is clear – private cryptocurrency issuers and users, be warned.

See also: From supply chain to supply loop

Simultaneously, the government-backed e-CNY has been pushed as an alternative. China Daily reported that white-listed users have reached 10 million and PBOC plans to use the Winter Olympics 2022 as a testbed for mass adoption. Consultants McKinsey & Co reports that between late 2019 and Jun 2021, RMB34 billion ($7.3 billion) has been transacted using e-CNY.

Having a state-backed alternative gives China a decisive say regarding the legal tender status of the currency and how it represents a cash-like liability to the central bank and therefore directly impacts the cash-in-circulation (M0) watched by all central bankers.

Notwithstanding the role of e-CNY in the overall policy picture, it doesn’t hurt that the business of electronics payments clearing is itself a burgeoning business ripe for disintermediation by the right players at scale.

Boston Consulting Group (BCG) reported in October this year, that global payment processing revenue clocked US$1.5 trillion ($2.05 trillion) in 2020 and is estimated to rise to US$2.9 trillion by 2030.

Significantly, the Asia Pacific - of which China’s market is by far the largest - accounted for the top share of 40.9% of total global payments revenue in 2020. Even better news is that this dominance will get further entrenched by 2025, when the Asia-Pacific will account for about 44% of global payments revenue.

With so much at stake, policymakers need little further encouragement to push e-CNY use as a credible candidate in this developing market.

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Source: BCG

External pressures

The e-CNY also has a much wider role in China’s overall trade position. China’s 2021 GDP, was US$ 14.72 trillion (World Bank 2022), accounting for a 17.4% share of global US$84.578 trillion GDP.

Paradoxically China’s yuan, accounts for only 2.42% of the total share of global payments according to the latest data provided by the Society for Worldwide Interbank Financial Telecommunications (SWIFT). The US dollar in contrast, dominates international payments as the settlement currency of choice.

Why does this matter?

China knows that simply by dominating international payments, the dollar gives American policymakers a decisive edge to leverage in its foreign policy. Witness the case of Iran. Since 2012, Iran was subjected to various financial sanctions, the most painful of which included blocking Iranian banks from SWIFT. This effectively cuts of all USD denominated trade since SWIFT is a necessary mechanism for funds transfer essential for any large trade payment.

The spate of Trump-initiated trade sanctions against China over the last 3 years was also a timely reminder that China urgently needs to insure itself by reducing its reliance on the dollar.

This is where China’s moves internationlise the use of the yuan as a means of exchange, dovetails into e-CNY. The e-CNY is a neat digital complement to the yuan as a means of payment. Domestically, there is an obvious place to start – China’s import/export trade with Hong Kong clocks US$500 billion annually. There is little reason why much of this can’t be settled using e-CNY. Once in place, this model can be exported for cross border payment.

The internationalisation of the yuan is a core Chinese policy interest for its continuing relevance to the world trade ecosystem. Speaking at the China Digital Finance Forum in September 2021, Fan Yifei, Deputy Governor of PBOC, has indicated that e-CNY will be part of a greater push to help yuan internationalization.

Quietly, the cross-border equivalent of e-CNY is already in place.

China made moves to replace SWIFT with its own CIPS (China International Payment Service) using an internationally accepted ISO20022 standard to replicate what SWIFT has been doing.

State-backed CIPS plans to increase its participating banks to 80 by end-2021 from the current 71, said its CEO Xu Zaiyue, in a Bloomberg interview.

As origination and endpoints for payment settlement, banks hold a key role in the use of the e-CNY. China’s policymakers are betting that with China’s dominant role in world trade, an increasing amount of trades would be settled in yuan, routed through CIPs for processing and complemented by e-CNY on the retail side. It doesn’t hurt that four of the largest banks globally are Chinese (Industrial & Commercial Bank of China, China Construction Bank Corp, Agricultural Bank of China and Bank of China)

Together with China’s share of global trade and the pulling power of Chinese banks, CIPS stands a chance of becoming a viable alternative to SWIFT. And with that, once CIPS is in wider adoption, the potential for integration to the retail e-CNY would be possible, enabling an integrated payments ecosystem within and outside China.

At about 2% of global payments, the yuan is still a long way from displacing the dollar, but together with the other pieces of the payments puzzle; China has a credible hope of chipping away this dependence and winning a place at the table for her day in the sun.

Photo: Signage for the digital yuan, also referred to as E-CNY, at a self check-out counter inside a supermarket in Shenzhen, China. The People's Bank of China is testing its digital money -- dubbed Digital Currency Electronic Payment, or DCEP -- in select cities. / Bloomberg

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