State Media Sheds Light on China’s Central Bank Digital Currency

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China’s state-owned media has shed some light on the expectations of Chinese financial authorities for the functionality and impacts of the country’s proposed central bank digital currency (CBDC), or digital currency/ electronic payments (DC/EP) system.

The Chinese central bank recently revealed that it had commenced internal testing of its CBDC with lenders and commercial outfits in at least four cities around China, including Shenzhen, Suzhou, Xiong’an and Chengdu.

The announcement arrives after a senior official with the People’s Bank of China (PBOC) announced in September 2019 that the launch of its CBDC was all but “imminent,” after work first commenced on the system in 2014.

An opinion piece published by state-owned news agency Xinhua highlights the expectations that Chinese authorities have when it comes to the functionality and influence of the CBDC.

The 20 April article entitled “The Launch of Digital Currency is of Benefit to Innovation of Monetary Policy” (数字货币推出利于货币政策工具创新 ) first of all highlights the two-tier operating system for issuance of the CBDC.

This will involve the Chinese central bank first exchanging digital currency with banks and other entities, who will in turn exchange CBDC with the public.

This will create two tiers of of exchange as opposed to a single-tier system, under which the central bank directly issues digital currency to the public.

“Because the central bank does not directly issue digital currency to the public, CBDC will not compete against the traditional operating model of commercial banks,” said Xinhua.

“It can make full use of the positive (role) of commercial banks and payments organisations in term of technological innovation.”

According to Xinhua Chinese regulators are particularly focused on the cash-replacement and payments functions of CBDC.

“From the perspective of digital currency usage, China’s CBDC is focused on the role of replacing cash, and mainly directed at small-sum retail scenarios.”

Xinhua also highlights the feature of the “controllable anonymity” (可控匿名) of China’s CBDC, as compared to the full anonymity permitted by physical cash.

“When using CBDC both parties can remain anonymous, and the privacy of the public can be protected.

“However when engaging in money-laundering, terrorist financing or tax avoidance, the real parties to transactions can still be traced.”

From the point of view of the Chinese central bank itself, CBDC is expected to result in the following changes to monetary policy:

  1. CBDC will strengthen anti-corruption, anti-money-laundering and anti-terrorist financing capability. Because cash transactions are completely anonymous and do not require accounts, they can be used for money-laundering, tax evasion and terrorist financing. CBDC is designed to have controllable anonymity, significantly replacing cash, while also helping the central bank to monitor the flow of funds and strengthen financial regulation.
  2. CBDC could increase M0 volatility, and increase the difficulty of targeted adjustments of money flows. CBDC is similar to cash, but during payments does not require “road costs” and waiting time, so usage is convenient. This could cause CBDC’s exchange scope and frequency to be higher than cash, increasing the difficulty of predicting flow leakage.
  3. The launch of CBDC creates conditions for the implementation of irregular monetary policy. Nominal interest rates cannot be less than 0% when citizens use cash, because if the central bank implements zero interest rates for deposits, citizens will choose to withdraw their deposits and stow the cash to avoid loss of value. This is unless the central bank rescinds a portion of cash, the difficulty and cost of which is high. In economics this is called the effective lower bound (ELB). However, if CBDC fully replaces cash, the central bank will be able to use programs to make the CBDC interest rate less than 0%. Additionally, with CBDC the central bank can directly increase the amount of CBDC in the wallets of citizens, and stimulate the economy via general release of cash to the public.
  4. CBDC can help the central bank to respond to the problem of ongoing reductions in cash payments, and an increasing expansion of digital cash or digital cash payment services provided by the private sector. In 2019 China’s M0 to GDP ratio was 7.8%, for a decline of 3 percentage points compared to 10.8% in 2010. In 2019 electronic payments accounted for 69.0% of all non-cash payments. The share of mobile payments reached 9.2%. This significantly affects the ability of the central bank to monitor monetary changes, and its ability to implement unified regulation of payments and settlements.
  5. CBDC can reduce the cost of monetary issuance. The production and transportation of cash and hard currency consumers significant labour, resources and time. Cash and hard currency can endure significant wear and tear during the process of usage. If the CBDC gradually replaces paper and hard currency with a lower face value, it can greatly reduce minting, transfer and wear-and-tear costs for money.

Xinhua points out that CBDC will have impacts for financial institutions:

  1. CBDC could increase the difficulty of liquidity management by commercial banks.
  2. CBDC can increase the efficiency of payments and settlements.

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