We live in extraordinary times, where Covid-19 has developed into a global black swan event, causing massive suffering and disruption for societies worldwide.
The pandemic exacerbated an already dangerously precarious economy, and has since cascaded into a rolling financial crisis throughout the world. Social distancing and economic shutdowns imposed to combat the pandemic have caused tremendous economic disruption. Differing from recent crises, which centred around financial services in 2009 and the internet in 2001, the latest has hit the entire real economy.
While extreme measures succeeded in preventing the exponential spread of the disease across mainland China, the costs of resulting disruption in lost productivity and long-term economic contraction have yet to be fully assessed.
China’s Purchasing Managers’ Index (PMI) has fallen to its lowest historical levels, as labour mobility, transportation links, supply chains and retail activity across the country have been forced to shut down completely.
Similarly, the US is suffering its worst unemployment in nearly a century. The systemic closure of large swathes of the economy combined with an inability to provide credit to the most fragile sectors of society could result in the largest economic depression the world has ever seen.
Even as some countries begin relaxing travel restrictions and their companies reopen for business, the full scope of the challenge to stimulate economic recovery remains daunting.
For China, one key potential tool is the digital RMB, announced by the People’s Bank of China (PBOC) at the end of 2019. As the world’s first central bank digital currency (CBDC) issued by a G20 nation, the digital RMB may offer powerful new technology-enabled monetary and fiscal policy tools to stimulate the global economy.
Widespread use
As an electronic ‘fiat liability’, CBDC has the potential to be universally accessible and used for payments by the general population, not just as a settlement tool for commercial banks. As stated by PBOC, the digital RMB is initially meant to replace notes in circulation and other assets easily convertible into cash.
The three hallmarks of a currency are as a unit of account, store of value, and medium of exchange. A digital currency is superior to physical banknotes in each of these critical attributes. Paper-based banknotes incur handling and safe storage costs, for counting cash and depositing in a bank account. But the digital RMB represents a secure store of value as it avoids risk associated with payment platforms from private companies and accounts at banks, all of which can default in a crisis. The digital RMB can be exchanged in a completely friction-free, costless manner as well as exchanged peer-to-peer, between digital wallets on mobile phones.
China has already gone largely cashless, fuelled by dominance of existing mobile and digital payment systems. The digital RMB will complete full digitalisation of money and payments. Models developed by the Bank of England have shown the aggregate effect of CBDC issuance of 30 per cent of GDP has potential to permanently raise GDP by up to 3 per cent, due to reductions in transaction costs, real interest rates, and distortionary taxes .
Introduction of the digital RMB provides an alternative system to the duopoly of Wechat Pay and Alipay, which represent a combined market share of 96 per cent of overall online retail payments. This would allow banks and other financial institutions to participate, making the sector more competitive, allowing effective monitoring and regulation, reducing overall system-wide financial risk.
The payment efficiencies of the digital RMB would have pronounced benefits for lower-income households and small businesses. Lower-income households tend to rely heavily on cash, and small businesses incur substantial costs for handling cash and interchange/exchange fees for processing payments via credit and debit cards.
The digital RMB would reduce transaction costs and radically increase financial inclusion for the rural and unbanked population. Additional opportunities would include the possibility of holding interest-bearing digital currency and online access to micro-loans and credit facilities. A digital nationwide roll-out could specifically serve the China’s estimated 800m rural population.
Efficiency gains and improved ‘trackability’ would encourage core consumption and increase economic activity. Improved data and monitoring of CBDC could provide banks with information they need to process loans to SMEs, which currently only access credit through shadow banking.
The digital RMB would reduce tax evasion, money laundering and other illegal activities. It does not require bank cards, linked accounts, or even working internet connection to conduct small-scale transfers. Instead, it is held in a purpose-specific digital wallet that is infrastructure-free, unlike existing payment systems. This allows the digital RMB to directly serve those without access to traditional financial services.
Monetary policy tool
A ‘programmable’ digital currency protected against inflation unlocks potential to provide direct transmission of monetary and fiscal policies in light of massive economic stimulus packages being announced around the world. During the credit crisis of 2009, massive quantitative easing stimulus plans resulted in inefficient allocations of credit, that were of limited impact in stimulating real economic growth. Banks and corporations used easy credit to systematically initiate massive stock buybacks and increase leverage.
In the Covid-19 crisis, the digital RMB would allow governments to directly stimulate consumption by targeting individual households. In the US, an estimated 40 per cent of Americans would struggle to pay an unexpected $400 expense, due to limitations in available cashflow and financial planning. The programmability of the digital RMB could facilitate provision of credit subsidies or cash relief with funds deposited directly into digital wallets of individuals and vulnerable SMEs. It can be programmed with restrictions on ‘non-desired’ uses, such as real estate speculation, peer-to-peer lending, corporate stock buybacks, even gambling and alcohol.
Direct-to-recipient stimulus avoids costs and inefficiencies of having capital trickle down through the banking system, evidenced by the failure of the US Paycheck Protection Plan (PPP) to effectively allocate a $350bn endowment, overrun by millions of applicants. The programmability and trackability of CBDC will allow for more efficient, result-based deployment strategies.
The digital RMB could facilitate cross-border settlement, particularly as the RMB is internationalised to Belt and Road partners. The Digital Silk Road is connecting people in developing nations online for the first time. These people represent the last untouched, high-growth markets in the world. The financial products and e-commerce opportunities would be very enticing to Chinese companies.
The digital RMB might encourage the developing world to shift from the US dollar to the RMB, especially as dollars continue to be dear during the pandemic. The pseudonymous nature of CBDC allows cross-border transactions, without the need for local bank accounts, financial services or even currency trading, which is of particular value for SMEs lacking resources to maintain sophisticated foreign exchange practices.
The digital RMB would also allow international tourists and visitors to access China’s mobile payment services ecosystem without needing to open a Chinese bank account. The resulting prominence of RMB in the global ecosystem should further internationalise the currency.
The digital future
The value of China’s digital economy expected to hit $16tn by 2035. Goldman Sachs indicates that digital finance could increase the GDPs of all emerging economies by 6 per cent, totalling $3.7tn, by 2025. These trends will accelerate as adoption of new technologies such as blockchain drive the next digitialisation revolution.
With CBDC, there is an opportunity for China to lead the world in development of the financial technology and infrastructure for digital assets.
Charles Chang is professor and deputy dean at the Fanhai International School of Finance, Fudan University, Shanghai. Additional research by Michael Sung, co-Director Fintech Research Center, FISF , Fudan University
