Authors: Dr. Faisal Ahmed and Hardik Gupta*
The global financial architecture has taken a leap with China testing its digital currency for the first time ever. It is known as the ‘digital yuan’ and was tested across the cities of Shenzhen, Chengdu, Suzhou and Xiong’an. In fact, the research and development process for the same was underway for at least five years. Chinese President Xi Jinping has already stressed on the need to develop artificial intelligence and 5G technologies at a large scale and has referred to them as the ‘new infrastructure’. The digital yuan, too, is a novel financial infrastructure in itself – a truly innovative mechanism. It has immense geopolitical implications for China and the world, the most important being its ability to avoid any sanction imposed by the United States.
A digital currency is different from cashless payments like those carried out through credit cards or apps. In such a transaction, the settlement is realised immediately, as against the cashless ones wherein banks still have an intermediating role. The digital currency creates avenues for communication between devices through which they can sense and exchange information and payments, and removes the conventional dependence on banks. From stimulus package to disbursement of development aid, and from direct money transfers to infrastructural investments like those meant for the Belt and Road Initiative (BRI), China can use the digital yuan in multifarious activities. This is deemed to strengthen its global competitiveness and enhance its position of strength in global negotiations too.
Within China, a high acceptance of this digital currency is expected. This can be attributed to the country’s excellent mobile phone penetration and a good record of financial inclusion. These factors coupled with a state-administered system – that the digital yuan is – will support the grassroots outreach of the digital currency ecosystem. The local population is already accustomed to using apps like Alipay and Wechat Pay, and is likely to embrace this digital currency without much hesitation. In fact, the introduction of digital yuan will have huge implications for the economy and the people as it helps reduce costs and increase convenience in making payments. Moreover, the People’s Bank of China, China’s Central Bank will be in a better position to control illicit payments and frauds. The digital yuan has direct benefits for public policy interventions too. It would help the government directly transfer any relief fund or stimulus package to overcome the adverse effect of Covid-19 on supply chains and livelihoods. Besides, the Chinese government also intends to transfer the salaries of government employees through the digital yuan.
Today, the United States dollar is a robust currency with utmost acceptability in terms of international transactions accounting for more than 90 per cent of the forex transactions. Such an acceptability and trust endows the United States with better negotiating position in the global financial markets. The United States, however, has often used its ability to apply economic sanctions to gain geopolitical advantages. For instance, the Society for Worldwide Interbank Financial Telecommunication (SWIFT) infrastructure requires all dollar transactions globally to be routed through the United States thus giving it a de facto ability to unilaterally freeze transactions. However, there have been calls in Europe for developing an alternative to the SWIFT payment system too.
The Chinese digital currency testing is now also threatening the American financial hegemony and is all set to provide an alternative to the dollar. If successfully implemented, it will move the world financial markets away from the dollar-centric system, and would also help the Chinese government to tackle any geopolitically motivated global currency disruptions. Today, the yuan occupies a very small chunk of the global payments and reserves. But being the world’s largest exporter, it is highly likely that China will push for global usage of the digital yuan among its trading and BRI partners.
During the ongoing pandemic, the American financial infrastructure has been exposed. For instance, there have been implementation related issues pertaining to relief fund transfer to the beneficiaries. It is therefore imperative that the financial technology infrastructure must be upgraded to boost economic activities and consequently the domestic growth. In fact, digital currency would rather provide more accuracy and transparency in such transactions. Specific sectors can be studied and selective relief packages can be provided to the most affected areas and population in times of crisis or a natural disaster.
The introduction of a digital currency can thus lead to a totally new outlook on public policy interventions in trying times. In fact, the United States too had toyed with the idea of a ‘digital dollar’ in the past with a most recent instance being the stimulus bill aimed at easing the adverse impact of Covid-19 outbreak. It was tabled in the United States Congress recently and proposed to implement the digital dollar wallets by January 1, 2021. Although, the digital dollar may pose a counter-narrative to China’s move, yet it remains a distant reality.
In fact, the emergence of digital yuan will potentially impact most economies – big and small – owing to their historical dependence on the dollar-centric financial system. The countries need to enhance their preparedness in terms of digitalisation of payments, its grassroots penetration, financial inclusion, and gradually reducing their dependence on dollar.
*Hardik Gupta is a participant in the international managers’ program at FORE School of Management, New Delhi.