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China's Digital Currency (II): Political and Strategic Stakes

China's Digital Currency (II): Political and Strategic Stakes
 Philippe Aguignier
Senior Fellow - Asia

This article, published in two parts and written by Associate Researcher in Institut Montaigne’s Asia Program Philippe Aguignier sheds light on the lesser-known story of China’s digital currency. This second part article explains the various measures taken by the PBOC in the last two years in order to prepare the ground for its new digital currency, and explains that the main motivations behind the project may not be the ones officially put forward. 

Clearing the way for the new currency

Perhaps the most important work performed by the PBoC in the last two years has been to deal with potential competitors with regards to its own digital currency project, namely crypto-currencies, and private digital payments systems operated by two of China’s internet giants.

With respect to the former, after years of hesitation, a decision was finally taken in September 2021 to ban all cryptocurrency transactions and activities. On several occasions, the authorities were even seen as encouraging the development of crypto-related activities in China. After all, Chinese operators did not become the world’s largest miners of bitcoins without the State giving its blessing. Not much has transpired from internal debates around the question, though we can guess that they have been lively, given the material economic interests involved, as well as the huge physical infrastructure in the form of servers required for mining bitcoins. The Chinese CBDC project started before Facebook started talking about Libra (later renamed Diem), so it is not a direct response to it, but the Libra announcement got the Chinese authorities extremely worried, and pushed them to accelerate their project.

The situation was much more complex with respect to Alibaba and Tencent. The market for retail payments in China presents two distinctive features: first, it is dominated to an extent unseen anywhere else by mobile phone-based payment solutions: the PBoC itself estimates the share of mobile-based payments as 66% of total payments by value, versus 7% for cards, and 23% for physical cards. Second, mobile payments are dominated by two players, affiliated respectively with Alibaba and Tencent, which together account for more than 90% of this segment. This means that a form of digital currency does exist and plays a major role in China today, but the system on which it runs is dominated by a duopoly of privately-owned digital conglomerates. The two dominant players are in a position to access huge amounts of customer data, while having an unmatched capacity to exploit this data in order to offer users various services. From financial services or e-commerce to online games, the list is almost endless, and these two groups have their fingers in almost every digital pie one can think of, with payments at the heart of their business model.

In retrospect, one should not be surprised that such a situation became a concern for the Chinese government and the Party. Any authority anywhere in the world would be concerned about such a situation, let alone China, which is extremely sensitive to any potential challenge to its power and authority. Ironically, Alibaba and Tencent had originally been encouraged to move into the field of payments by the financial authorities themselves, who wanted to inject some degree of competition into a banking system, where the main players had become too entrenched and too complacent to be truly innovative. This experiment turned out to be too successful, however, once the authorities understood the extent of the power that the digital giants had accumulated.

The Chinese authorities decided that digital payments and digital currency were subjects too strategic to be left to the private sector, and that the State had to take over. 

At some point, the Chinese authorities decided that digital payments and digital currency were subjects too strategic to be left to the private sector, and that the State had to take over. The challenge was then to do this in a way that would preserve as much as possible of what had been built - including the most modern, efficient, and cheap infrastructure for retail digital payments globally - and from which China had already benefited (largely thanks to innovations introduced and developed by Alibaba and Tencent).

The PBoC and regulators in various fields submitted Alibaba and Tencent to a very organized assault in almost every aspect of their business - including the ones not directly related to payments. One of their aims was to force the two firms to open their systems. The details are not fully known, but the outcome is: over the last two years, Alibaba and Tencent had to accept many measures limiting their own business capacities, to share their platforms with other players, and to make ample room for the new currency promoted by the PBoC. To illustrate this point, in any scenario where a user would have previously settled a transaction through their Alipay or WeChat account (i.e. a majority of daily-life transactions), the user will now also have the option to settle directly from an e-CNY wallet not connected with the Ali or Tencent/WeChat ecosystems. When this happens, Alibaba and Wechat will no longer have access to the customer data flows they used to capture, which could deal a significant blow to their business model. In a way, the PBoC is doing to Alibaba and Tencent what these two companies had themselves done to commercial banks a few years ago, when they squeezed them out of the payment business.

The PBoC got what it wanted: the existing system continues to work, but with its new currency at the center of the system. The digital giants were probably presented with "offers they could not refuse" and had to swallow a bitter pill, but at least they still have a place in a system that they played a fundamental role in creating. For Alibaba and Tencent, this may not be the end of the story: the agility and innovation that these companies have demonstrated in the past indicates that they will fight to find ways to continue to attract users and give them reasons to transact within their ecosystems. It is not to be taken for granted that users will adopt in mass the new system, especially since (as seems to be the case today), the new e-CNY does not offer a radically different or improved user experience. Additionally, for general users, the higher level of security provided by the so-called "sovereign digital currency" may not be as appealing as Chinese authorities claim, while the current payment system operated by Alipay and Tencent is seen as safe and reliable. However, if this happens, and the e-CNY threatens to be a commercial flop, the PBoC will no doubt find ways to tilt the balance in its favor, for instance by forcing certain users or types of transactions to use the new central bank currency (welfare-related transfers, or payments by SOEs, for instance).

What is the point of all this?

For all the technical skills and tactical prowess demonstrated by the regulators and the PBoC in promoting their vision of a digital currency, one major question remains unanswered: what is the point of all this? The PBoC does have a long list of motivations for its project, but some of these do not stand to closer scrutiny, and the e-CNY sometimes looks like a solution waiting for a problem. In addition, the bar is set higher than elsewhere, as China’s payment system is already so efficient.

Replacing cash is an obvious motivation for introducing a central bank digital retail currency as an alternative to banknotes: it could offer substantial cost savings, as banknotes are expensive to print (security features to avoid fakes) and even more to store or manipulate (armored cars for cash collection, etc.). However, this will not happen before a long time, if ever. The share of cash in overall payments does decrease regularly, but the total amount of cash in circulation is still increasing in many countries, including in China according to the PBoC.

Safety is another consideration put forward by the PBoC: a currency fully backed by the central bank does decrease systemic risk (by reducing the risks associated with the failure of a payment provider), but this can also be achieved through the strict regulation and supervision of intermediaries.

Offering citizens a better payment experience seems almost beyond reach in the Chinese context. Chinese citizens, as mentioned above, benefit from one of the most advanced and innovative payment systems in the world, which is also cheaper than any known alternative. While electronic payments are expensive in most countries, their costs are often unseen by the end-user as they are borne by merchants.

Safety is another consideration put forward by the PBoC: a currency fully backed by the central bank does decrease systemic risk.

The Chinese QR code-based system is much cheaper than card-based systems in the US or parts of Europe, especially for merchants. Arguably payment services are offered for free or quasi-free in China, only because the payment providers are able to capture and monetize the value of the data of their users. This will not be the case (or to a lesser extent) with a CBDC, but this is an argument about benefit-sharing, not about overall costs.

Facilitating financial inclusion is also a motivation, but again, it is unclear what concrete improvements a CBDC would bring in comparison to the existing system, which has already brought the benefits of electronic payments to the country’s rural and remote areas. The PBoC has said that it will also introduce physical wallets, but these will not differ significantly in their functionalities from stored-value cards, which have long been in use.

According to the PBoC, the e-CNY is meant "to provide a widespread, inexpensive and convenient digital payment system, which would expand access to financial services and promote fair growth" (提供广泛、廉价和便捷的数字支付系统,从而扩大金融服务普及性,促进更公平的增长). However, as pointed out previously, the e-CNY’s real contribution to these factors remains limited, given the success of existing digital payment services like Alipay and WeChat Pay. In fact, the two digital wallet giants are often praised for their contribution to the popularization of digital payments. Hence, the official argument does not seem to provide enough justification for such a significant undertaking. 

In some other areas, benefits for the PBoC and the authorities are clearer. Curbing the power of the digital giants is certainly not the only motivation behind the project, even if it has become an important one.

One concrete benefit of implementing the e-CNY is that the PBoC will be in a much stronger position to exercise control over the usage of money, and hence fight against money laundering, tax evasion, bribery, etc. However, the PBoC - and the State and Party behind it - will also potentially have a formidable new tool for social control at their disposal. The PBoC seems worried about how this question could be perceived, and has developed a concept of "controllable anonymity" (可控匿名, officially translated into "managed anonymity"). This acknowledges that the central bank will indeed have extensive powers, but pledges to use them with restraint. For instance, anonymity will be preserved for small transactions (see Part one). However, not everyone will fully believe that this will indeed be the case. . For instance, to acquire the simplest form of e-CNY wallet, with the lowest limits, only a phone number is required. The catch is that an ID number has to be provided in order to obtain a phone number, so the authorities can trace identity, if they so wish. 

Chinese authorities and the PBoC strongly wish to reduce China’s dependency on the US dollar, and to promote the RMB as an international currency in the long term.

Furthermore, Chinese authorities and the PBoC strongly wish to reduce China’s dependency on the US dollar, and to promote the RMB as an international currency in the long term. However, most observers, and the PBoC itself, agree that in its current form, the e-CNY, as a domestic and retail-oriented project, will not have a meaningful impact on the internationalization of the RMB. This would require, among other things, a further opening of financial domestic markets, and the quasi-disappearance of restriction on the capital account - measures that China is not prepared to take at this point.

One should not, however, underestimate the potential importance of the e-CNY in the long term. For instance, it could contribute to the usage of the RMB in international trade, which is one of the key "components" of an international currency. This will require further developments, technical as well as legal, as international trade is much more complex and regulated than its domestic counterpart, and will take time, although things could happen faster than anticipated. Other potential applications involve Chinese tourists abroad (if and when they resume traveling). A credible and well-established CBDC may therefore become a very valuable tool to have in China’s future toolbox, even if it seems to be of limited use today.

Last but not least, China’s e-CNY project is generating a lot of positive buzz: China is widely considered at the forefront of an innovative project, in line with modern times. So far, other major countries seem to be unsure of what to do, and may even end up following China’s lead. On a related topic, the speed and determination with which China has cracked down on its digital giants has generated positive comparisons to the supposed incapacity of US or European authorities to tackle similar issues in their markets. 

Overall, it appears clear that China has strong reasons to push forward with its e-CNY project, although the real reasons may not be the ones that it puts forward. Undeniably, and whatever the real reasons may be, China is far ahead of any other major economy in this respect. What is more difficult to assess is how significant this will turn out to be. Will it be one of the major financial innovations of the 21st century, as some enthusiastic observers put it? Or just another element in a long chain of technological improvements facilitating the digitalization of the world’s economies? Or, more ominously, will it be another illustration of China’s party-state appetite for ever more surveillance over its citizens?




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