Comment on “Developments and Implications of Central Bank Digital Currency: The Case of China e-CNY”

Abstract

Xu (2022) provides an overview of the structure and purpose of China's e-CNY and also discusses its implications for the international monetary system. In this comment, I will expand on some of the points in Xu's paper, drawing on Prasad (2021) and a forthcoming Hoover Institution report (Duffie et al., 2022) that examines the implications of the e-CNY for US policy and geopolitical influence (I am a member of the working group).

The renminbi has become the fifth most important currency in international payments (based on SWIFT data). In 2016, the International Monetary Fund (IMF) included the renminbi in an elite basket of currencies that comprise the Special Drawing Rights, making it an official reserve currency. Since then, the renminbi's progress has stalled. The renminbi's share of international payments has fallen to about 2% and the share of global foreign exchange reserves held in renminbi-denominated assets has plateaued at about 3%.

China's rollout of the e-CNY trials makes it one of the first major economies to do so. The second phase of e-CNY trials is already underway in a number of major metropolises and with a number of financial and nonfinancial institutions participating. Will the e-CNY be a game changer that elevates the renminbi's role in international finance?

The e-CNY will initially only be usable for payments within China, although this could change over time. In my assessment, China's Cross-border Interbank Payments System (CIPS) is a more important innovation that makes it easier to use the currency for international transactions. CIPS also has messaging capabilities, which makes it possible to bypass SWIFT and could help evade US direct as well as indirect financial sanctions, a tempting prospect for many governments around the world. As the renminbi becomes more widely used, countries that have strong trade and financial links with China might start to invoice and settle their trade transactions directly in that currency. The e-CNY could eventually be linked up to the cross-border payments system, further digitizing international payments.

However, the e-CNY by itself will make little difference to the renminbi as a reserve currency. One reason is that cross-border capital flows into and out of China are subject to restrictions. Another is that the renminbi's exchange rate is still managed by China's central bank. The Chinese government has certainly reduced restrictions on capital flows and signaled its plans to eventually have an open capital account. Moreover, the central bank has committed to reducing its intervention in foreign exchange markets and letting market forces have their say.

Still, in reality, China's government has shown that, when pressures build up for significant currency moves as capital flows shift, it will revert to its command and control mentality by tightening capital controls and exchange rate management. Foreign investors, including central banks, will therefore remain wary about the prospect of unfettered movements into and out of China's capital markets at market-driven exchange rates.

In any event, the renminbi is unlikely to be seen as a safe haven currency. Foreign investors' trust is built on a system that adheres to the rule of law, which even the government is subject to, and a political system that has built-in checks and balances. Some have argued that China does have the rule of law and has sufficient self-correcting mechanisms that prevent the government from undertaking policy actions that could hurt financial stability and/or growth.

This is not a substitute for an institutionalized system of checks and balances such as that in the USA—where the executive branch, the legislative branch, and the judiciary have independence from and serve as constraints on the unbridled exercise of powers by the other branches. US institutions were severely tested under the Trump administration but seem to have survived. Given US economic dominance, deep and liquid financial markets, and still robust institutional framework, the US dollar still remains the major reserve currency by far.

Any gains the renminbi has made in recent years, both as a payment currency and as a reserve currency, have mostly come at the expense of the euro and the British pound sterling. Even when the IMF inducted the renminbi into the special drawing rights basket of currencies, its weight of 10.9% came largely at the expense of the other currencies in the basket—the euro, the pound sterling, and the Japanese yen—rather than the dollar.

The e-CNY and China's cross-border payments system will together enhance the renminbi's role as an international payments currency if China's government continues to reform its financial markets and remove restrictions on capital flows. But they will not materially alter the renminbi's role as a reserve currency or undercut the US dollar's status as the dominant global reserve currency.