Home / Opinion / Views /  Could China’s digital renminbi pose the US dollar a challenge?

Globally, as many countries are progressing on their central bank digital currency (CBDC) research, important questions have arisen. As China began testing a digital version of its renminbi (units of which are measured in yuan) in major cities last year, interest in CBDCs has gained global attention, especially the potential impact of this exercise on the internationalization of the renminbi. The digitalization of China’s currency, combined with other economic developments there, has led many to wonder if it will pose a challenge to the hegemony of the US dollar as a reserve currency. While such arguments may seem far-fetched now, one can’t deny that CBDC developments may prove transformative for the international economy.

A reserve currency is a foreign currency that is typically held by central banks as a part of their foreign exchange reserves. Such reserves are held for various reasons—to finance international transactions, maintain confidence in the domestic currency, etc. Reserves are denominated in currencies that are widely used for international payments. The US dollar is the world’s dominant reserve currency and has been so for years. This is consistent with its wide international use—as the most traded currency in foreign exchange markets and most used for trade invoicing. While many geopolitical factors are responsible for reserve-currency status, the economic size of the issuer country and its dominance in international trade play significant roles in achieving it. Here, some economists point out that China appears to have the necessary ‘hardware’ to give the US dollar competition as a global reserve currency. China has overtaken the US as the world’s largest trader, and, as per estimates released by the International Comparison Programme, China’s gross domestic product (GDP) at $19.6 trillion in 2017 by purchasing power parity, was more than the US’s $19.5 trillion. However, some economists believe that GDP at actual exchange rates may be a better parameter for geopolitical power. On this, some studies estimate that China will overtake the US to become the globe’s largest economy by 2028.

According to an International Monetary Fund (IMF) study, the emergence of digital currencies and advances in payment systems could alter the significance of traditional drivers of reserve currencies, and result in the emergence of new reserve currencies. The aforesaid data on China’s economy must be read along with other recent developments in the People’s Republic of China. The internationalization of the renminbi has been a strategic goal for China. Beijing’s efforts culminated in its 2016 inclusion in the IMF’s Special Drawing Rights basket of currencies. As an extension of its moves to internationalize its currency, Beijing is pursuing CBDC research aggressively. China is believed to be at an advanced stage in its retail CBDC research. In April 2020, China piloted a version of its digital renminbi in four major cities for retail use. China has also joined the central banks of Hong Kong, Thailand and the UAE to develop a prototype to facilitate real-time cross-border payments using a CBDC. The adoption of a digital renminbi for cross-border payments may allow China’s financial system to reduce its reliance on the US dollar, and limit the involvement of foreign financial institutions as well as the oversight of foreign authorities. Currently, cross-border payments are costly and time-consuming, due to the involvement of several parties, exposing parties involved in transactions to credit and settlement risk. If China can leverage its first-mover advantage to meet the need for a digital currency and build an efficient CBDC system that can address these pain points in cross-border payments, its CBDC could prove attractive for international trade. The potential opportunities presented by a digital renminbi for enhancing China’s influence in global financial markets are supported by measures like China’s Belt and Road Initiative and bilateral trade relations with countries, especially in the Southeast Asian region. This region is intricately connected with China through trade and investment ties, and Beijing will probably use these to drive demand for a digital renminbi. Some even point out that a digital currency will allow China’s CBDC infrastructure to bypass US sanctions and also enable users to avoid the scrutiny of the SWIFT system. This may be relevant for sanctioned countries like Russia, Iran and Venezuela. Of course, this itself may be a cause of concern.

However, these developments seem insufficient to replace the US dollar as the world’s reserve currency. The issuer’s policy credibility and the depth and liquidity of its financial markets are critical. In China’s case, capital controls, protectionist policies and a lack of transparency have often been pointed out as factors that undermine global investor confidence. Unless these issues are addressed by Beijing, a CBDC alone may not pose a credible challenge to the US dollar. However, that could change. Over the longer term, a shift in Chinese policies, coupled with the existence of a widely available and efficient CBDC system run by China, may make the renminbi a credible contender for reserve-currency status.

Shehnaz Ahmed is the fintech lead at the Vidhi Centre for Legal Policy.

These are the author’s personal views.

Subscribe to Mint Newsletters
* Enter a valid email
* Thank you for subscribing to our newsletter.
Recommended For You
Edit Profile
Get alerts on WhatsApp
Set Preferences My ReadsFeedbackRedeem a Gift CardLogout