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Central Bank Digital Currency - An Important Driver on the Path of RMB Internationalization

China is at the forefront of the world in the competition for central bank digital currencies. At present, digital RMB is mainly based on domestic retail payments, and we cannot expect it to bring a qualitative leap to the internationalization of RMB in the short term. However, this peer-to-peer transmission mode based on digital currencies has enormous potential in the field of cross-border payments; Not only can it improve the low efficiency, high cost, and difficult supervision of cross-border payments, but it can also provide a relatively equal platform to promote real-time synchronous settlement of foreign exchange transactions in multiple regions. In the era of central bank digital currency, the circulation scale of RMB will benefit from the optimization of cross-border trade and investment settlement procedures, which will help promote the internationalization of RMB.

The era of central bank digital currency

For reasons such as maintaining financial system stability, assisting in the implementation of monetary policy, and supporting more efficient domestic and cross-border payments, the research and issuance of legal digital currencies have become a focus of central banks around the world in recent years. Currently, central banks in multiple countries around the world are accelerating the exploration of the issuance and implementation of digital currencies. According to data statistics, over 60 countries have conducted experiments related to digital currencies in the past year, which is higher than the previous year's more than 40. Currently, central banks around the world are shifting their attitude towards digital currencies from caution to acceptance and exploration. The third survey report by the Bank for International Settlements on digital currencies shows that among the 65 central banks covered by the questionnaire, 86% of them stated that they are at least considering the pros and cons of issuing digital currencies, a slight increase from 80% the previous year.

Developed countries such as the United States, Japan, and South Korea are gradually shifting their attitudes towards digital currencies from a wait-and-see approach to open testing. Powell stated that the Federal Reserve is participating in research and development projects related to the digital dollar, which will make payments faster and more efficient. However, there are still many issues that need to be addressed in terms of technology, privacy, and security. The Bank of Japan conducted the first phase of concept validation for its central bank digital currency in April 2021, focusing on testing core basic functions such as issuance and circulation. The test will last for one year. South Korea began preparations for a digital currency in early 2020 and is currently planning to conduct simulation tests on the functionality of its central bank digital currency. The UK government recently announced that the Ministry of Finance and the central bank will jointly establish a central bank digital currency working group to conduct research on digital currencies. At present, the Bank of England's promotion of digital currency is still in its early stages. It will make specific assessments of the scenarios, risks, data, and privacy impacts of currency in order to establish a more advanced financial services sector and promote the efficient development of digital finance. The European Central Bank recently stated that it hopes to implement a digital euro within 5 years.

Developing countries are also actively deploying digital currency testing. Thailand has already started internal testing of interbank digital currencies in 2018, and it will test retail central bank digital currencies next year, with plans to fully implement them in the next 3 to 5 years. South Africa is collaborating with several central banks to study the feasibility of central bank digital currencies. Venezuela announced the issuance of the "Petro" in December 2017; In 2020, Venezuelan banks began accepting Petro, and gas stations across the country have used Petro for payments.

The purpose of issuing digital currencies varies between developing and developed countries. In addition to common goals such as diversified competition in payment methods and improving financial stability, developing countries tend to focus on inclusive finance, while developed countries focus more on consolidating monetary sovereignty and facilitating the regulation of negative interest rates. For example, the digital dollar aims to consolidate the international currency status of the US dollar. The White Paper on Digital Dollars mentions that in addition to improving payment efficiency and optimizing central bank payment channels, digital dollars will also support the US dollar's status as a world reserve currency. Meanwhile, the highlighted distributed ledger technology (DLT) is more likely to be applied to non US domestic users, indicating a higher probability of digital dollars being used in cross-border payment scenarios; On the other hand, for countries such as Switzerland and Japan that implement negative interest rates, the introduction of digital currencies will expand the space for monetary policy and be more conducive to the implementation and implementation of negative interest rate policies.

In the era of central bank digital currency, China is at the forefront of the world's digital currency layout. The China Financial Stability Report released by the People's Bank of China in 2020 mentioned the progress of digital RMB research and development. As one of the first central banks to launch the central bank's digital currency, the People's Bank of China has started preparations since 2014, accelerated its progress in 2019, and entered the closed internal testing stage in 2020. It has basically completed top-level design, standard formulation, functional research and development, joint commissioning and testing, and is in a leading position in the world. The digital RMB, as an extension of legal tender in the digital world, is backed by government credit and has unlimited legal solvency. From the perspective of operation system, digital RMB adopts a dual layer operation system and adheres to a centralized management model. The central bank exchanges currency with the public through commercial banks or other operating institutions. In terms of reserve system and credit guarantee, digital RMB pays 100% reserve to ensure that issuance and withdrawal do not affect the total amount of currency issuance.

The scale of China's digital economy has reached 35.8 trillion yuan in 2020, accounting for 36.2% of GDP. As the cornerstone of the development of the digital economy, the digitization of the renminbi will be the first step in the construction of China's digital currency. Digital RMB is different from traditional payment methods in that it uses new technologies such as blockchain to support payment scenarios and improve transaction efficiency. The current development focus of digital RMB is to serve China's massive 1.4 billion consumers, establish a solid retail payment system, and optimize the application of domestic retail payments.

Cross border payment of digital currency and internationalization of RMB

Although digital RMB is not yet planned to involve cross-border payments at this stage, with the gradual maturity and wider application of digital currency technology, the huge potential of this peer-to-peer transmission mode in the field of cross-border payments will also be released. The current global cross-border payment system is mainly centered around SWIFT (Society for Worldwide Interbank Financial Telecommunication) and CHIPS (New York Clearing House Interbank Payment System). In this payment system dominated by developed countries, developing countries have almost no say, and once excluded from the trading system, their cross-border commercial activities will be greatly restricted. SWIFT is often used by developed countries as a means of financial sanctions to pressure governments of other countries. In history, the United States imposed financial sanctions on countries such as North Korea, Russia, and Iran by cutting off the SWIFT payment settlement channel, cutting off their financial transactions with external banks.

A distributed payment network based on digital currencies can not only improve the low efficiency, high cost, and difficult supervision of cross-border payments, but also provide a relatively equal platform to promote real-time synchronous settlement and foreign exchange transactions across multiple regions. All countries have the opportunity to establish their own cross-border payment system, and underdeveloped countries can also join the cross-border payment system built by economically strong countries, thus forming a payment alliance. At the same time, countries can also join different payment systems according to their own economic activity needs. This relatively free and open system is expected to create a fair competition environment, and the cross-border payment system monopolized by developed countries may be reshaped. Previously, the central banks of Canada and Singapore successfully implemented cross-border payments on the blockchain using central bank digital currencies in the Jasper Ubin project. At present, China has initiated the "Multilateral Central Bank Digital Currency Bridge" research project with multiple regions and countries such as Hong Kong, Thailand, and the Arab world, exploring the use of distributed ledgers under blockchain to achieve 24/7 synchronous settlement.

In the past few years, the Chinese yuan has made certain progress on the path of internationalization. However, in terms of currency usage, the renminbi still has a long way to go before it can truly achieve "internationalization". Since the inclusion of the renminbi in the SDR basket in October 2016, over 70 central banks or monetary authorities worldwide have included the renminbi in their foreign exchange reserves. However, the share of the Chinese yuan in global reserve currencies is only 2%, lower than the 60% of the US dollar. In global cross-border payments, the proportion of RMB usage is less than 2%, while the total proportion of USD and EUR is nearly 80%. Although China is one of the main engines of world economic growth, with about 18% of the world's total economic output and 13% of its total import and export trade, the influence of the renminbi in the global monetary system is minimal.

Some people believe that the emergence of digital RMB will bring a qualitative leap to the internationalization of RMB, but the process of currency internationalization is not achieved overnight. Due to the inertia of currency usage, new currencies must cross a high threshold to become international currencies. In history, only a few currencies such as the US dollar and the euro have gained true international status. In fact, the internationalization process of the RMB depends more on institutional and policy choices. The internationalization of currency is closely related to the size of a country's economy, trade volume, and degree of openness to the outside world. At the same time, currency stability is also an important consideration; During periods of exchange rate system reform or financial crisis, excessive currency fluctuations will also constrain the development of currency internationalization. Technological innovation cannot change the path of currency internationalization, but there is a possibility of enhancing the driving force of currency internationalization.

At present, digital RMB is mainly used to improve the efficiency of domestic retail payment systems, and cross-border payments are not the focus. Therefore, our expectation that the central bank's digital currency will bring a qualitative leap to the internationalization of the renminbi in the short term is not very reasonable. In the foreseeable future, the US dollar is likely to remain the primary reserve currency. However, as more and more central banks issue digital currencies and the application of digital fiat currencies in cross-border payment systems becomes increasingly mature, the digital renminbi will provide convenience for the internationalization of the renminbi. The peer-to-peer transaction mode of digital currency without intermediaries not only has the advantages of low cost and high efficiency, but also can bypass the expensive and complex SWIFT system, greatly facilitating the settlement of RMB in cross-border trade and investment.

When the central bank's digital currency can be widely applied to cross-border payments, digital currency can catalyze the internationalization of the renminbi by increasing the circulation scale of the currency. The cross-border payment system based on legal digital currency can provide an efficient and low-cost payment system, facilitate economic activities between China and trading partners, and expand the use and circulation of RMB. Under this payment system, the central bank's digital currency may first be applied to cross-border retail payments, including cross-border business visits, retail online shopping, etc. The countries along the "the Belt and Road" are an important target for the development of cross-border payment systems. The "the Belt and Road" runs through the Eurasian and African continents, connecting more countries and regions along the line with Russia, Saudi Arabia, India and other developing countries with strong development momentum as nodes. The "the Belt and Road" will promote regional cooperation and exchanges between China and neighboring countries, and activate a new round of opening up. In the digital currency era of the central bank, China can form a payment alliance with these countries along the "the Belt and Road" to initially establish an international settlement system. With the continuous promotion and in-depth development of the "the Belt and Road" initiative and the construction of domestic free trade ports, the demand for RMB internationalization is increasing. Digital RMB is expected to become an important driver of RMB internationalization at the right time.