Cross-border role of China’s digital currency: Still embryonic technically and even more so institutionally

China is taking the lead in the global race to develop a Central Bank Digital Currency (CBDC). As the first major central bank to enter the pilot phase, the People's Bank of China (PBoC) is getting closer to the official launch of its own digital currency. At the current stage, the E-CNY is only designed to partially replace the physical cash in circulation domestically as its usage has markedly declined. But China’s ambition is obviously beyond that. The collaboration with the Hong Kong Monetary Authority (HKMA), the Bank of Thailand (BOT) and the Central Bank of the United Arab Emirates (CBUAE) to experiment the cross-border use of the E-CNY in these three jurisdictions is a good example. On top of that, the joint venture set up with SWIFT point to China’s aspirations, namely facilitating the global use of its new digital currency and, possibly, having the RMB become a reserve currency one day.

There is no secret behind China’s eagerness to internationalize its currency. The first attempt was centered on facilitating Hong Kong as the global hub for offshore RMB business and then extended to other offshore centers, which did not work out well after the 2015 Chinese equity and currency shocks. This time around, China is trying again by fostering the cross-border acceptance of its digital currency, profiting from a first mover advantage. This is not only important in the long run but also immediately as it can help China bypass the use of the dollar when and if needed. This is particularly relevant since the US has stepped up the use of the USD extraterritoriality to contain China, whether with sanctions and beyond. The fact that RMB only captures a tiny share of global payments, roughly 2%, adds to the urgency.

That said, the internationalization of a currency needs not just technical preparations. It also requires certain conditions to be fulfilled for its global acceptance, namely preserving its value, through price stability, offering a large pool of highly liquid assets and allowing full capital account convertibility for money to instantly flow in and out of RMB. This means that the Chinese government will need to take additional steps towards the liberalization of the capital account so as to enhance the full convertibility of the RMB. 

A key question is whether the E-CNY may help Chinese authorities to square the circle, namely to allow for more capital account openness while still being able to trace capital flows and act accordingly. This explains why E-CNY’s traceability under the design of “controlled anonymity”, is key, as it allows to control seemingly free financial flows. In other words, the digital currency could offer a way to promote RMB as an international currency while still keeping control of cross-border flows. However, the technical barrier for a cross-ledger solution and the institutional differences make it easier said than done. Data sharing of financial transactions is also an important stumbling block.

Another important factor that needs to be improved is the liquidity of RMB financial assets. While the size of the bond market has grown rapidly since the global financial crisis, it is dominated by corporate and FI credit. More liquidity on central government paper is needed with a longer yield curve and clearer benchmarks. But whether the E-CNY can help on this front remains a question.

In short, a digital currency for a non-convertible country with massive economic size like China has very different implications from those of other digital currencies. A key question is whether the E-CNY can help China internationalize its currency. The answer is probably yes, especially in terms of cross-border payments, such as retail and tourism spending linked to Chinese consumers overseas. In addition, whenever bypassing the USD is the case, the E-CNY has a chance. For cross-border funding and investment, much more will need to happen to boost the overseas use of the E-CNY, or the RMB more generally.

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