Asia Embraces CBDCs: Economic and Geopolitical Factors

Not long ago, China's CBDC pilots were considered underwhelming, failing to meet expectations. But data recently disclosed by the People's Bank of China (PBOC) hints at China’s intent to dive deeper into the global financial markets.

At a conference hosted by the Monetary Authority of Singapore (MAS) in mid-July, the leader of the People's Bank of China, Yi Gang, shared significant statistics the digital yuan has attained since its introduction 18 months prior. The transaction volume as of June 2023 had already risen 70% compared to August 2022.

Moreover, the Governor of the People's Bank of China disclosed readiness to establish dealings with Singapore based on the digital yuan. Initially, this is likely to involve retail transfers, offering insight into the potential interplay between China's CBDC and the Singapore dollar in real time.

In addition, Yi Gang recollected that in January, the People's Bank of China endeavored to apply CBDC for securities acquisitions and the execution of smart contracts. In the middle of July, the Bank of China (Hong Kong) initiated a fresh "pilot" scheme for deploying the digital yuan at retail outlets in Hong Kong. This trial will help examine the advantages and disadvantages of cross-border CBDC transactions. 

Ravi Menon, the Managing Director of the Monetary Authority of Singapore, expressed that the city-state is diligently observing the Chinese experiment while simultaneously contemplating various uses of digital currency.

In turn, China is vocal about its aspiration for the digital yuan to gain recognition in the global financial market.

Just one week after the Singapore conference, Pan Gongsheng stepped into the role of the head of China's Central Bank, taking over from Yi Gang.

It's currently unknown whether there will be shifts in the Central Bank's financial policy, including concerning CBDCs. However, it's crucial to understand that, unlike Western democracies, the head of China's Central Bank has limited autonomy when it comes to making strategic decisions. The strategy is set by the Chinese Communist Party, and the head of the Central Bank simply determines its execution.

For the past two decades, China has been persistently encouraging its primary trade partners to transition to yuan-based settlements. However, the central banks of these partner countries have thus far declined these proposals. Adopting the yuan would mean they would need to hold reserves of this currency to facilitate trades and service foreign trade contracts with banks and agents. The world predominantly operates within the zone of dollar transactions, with the euro having a partial presence. Furthermore, China's own Central Bank has to maintain reserves in both dollars and euros to import raw materials, components, and technologies.

The evolution of China's CBDC simplifies cross-border transactions and will allow China to gradually draw other countries into the yuan's sphere of influence. This will give rise to a financial zone that competes with the combined financial ecosystems of the U.S. and EU. Initially, this zone is likely to include neighboring states such as Hong Kong, Singapore, and Indochina countries.

One significant aspect of strategic planning is that what may be perceived as a failure or setback in the Western world may be viewed as a positive step in China. For instance, the total volume of CBDCs accounts for less than 1% of all yuan in circulation. While we might dismiss this figure as insignificant, the Chinese believe that “the journey of a thousand miles begins with one step.” Unlike their Western counterparts, China's strategic plans span over decades. 

A parallel development path appears to be chosen by another regional power – South Korea. According to the country's leading business journal, Maeil Kyungjae, the local Hana Bank intends to initiate a CBDC pilot project in collaboration with the Bank of Korea. At present, South Koreans are looking at CBDCs as an alternative to stablecoins. Despite their backing by solid traditional assets, stablecoins are susceptible to volatility. In the view of South Korean financial circles, CBDCs can help mitigate this risk. Consequently, a rivalry between two central bank digital currencies — the yuan and the won — may arise in the region over time.

The truth of the matter is, the reception towards CBDCs remains somewhat frosty in the West. Central banks, financial sectors, and politicians are fond of discussing the advantages of central bank digital currencies. Yet, there are several 'red flags' that Western institutions cannot afford to overlook. Take, for instance, the risk of third-party control over CBDC deposits and accounts inherent in their code. While this doesn't pose much of an issue in China, given their absolute oversight over all financial transactions, it could be a major contention for Western democracies.

In the middle of June, President of the European Central Bank Christine Lagarde announced that a decision regarding the establishment of a digital euro would be made by the end of October. However, the broad deployment of CBDCs isn't something we'll be seeing shortly.

Additionally, it might occur that some EU countries will embrace CBDCs while others won't. Persuading them to incorporate the digital yuan into their transaction mechanisms could prove to be an insurmountable challenge.

The stance on CBDCs in the United States is even more ambiguous than it is in Europe. Statements about banning digital dollars have become commonplace among opposition politicians who take pride in their skepticism. Recently, Congressman Warren Davidson joined the ranks of these "crypto skeptics," expressing grave concern about CBDCs. According to him, they ought to be prohibited. 

Finally, it's worthwhile to recollect a recent statement by the SEC Chair, Gary Gensler, during his interview with CNBC.

Gensler's stance may be explained by the fact that for some Americans, the term "digital dollar" is closely tied to cryptocurrency. After the collapse of FTX, coupled with lawsuits against crypto companies and exchanges, there's growing public support for calls to limit, or even prohibit, the digital dollar. In other words, the arrival of CBDCs in the United States is not on the immediate horizon. Furthermore, there's no guarantee that every jurisdiction within the US will favor its introduction – each state reserves the right to independently make this decision.

At the moment, it's apparent that neither the economic nor the political spheres of Europe and the US are planning to back China in its geopolitical aspirations. Without the introduction of CBDCs in Europe and the US, there's no role for the digital yuan as a world digital currency. Thus, it appears that the People's Bank of China's CBDC is likely to hold only regional status shortly. However, it's worth reiterating that China's planning timeframe differs from that of the West. China is unlikely to abandon its plans to turn the digital yuan into a currency for worldwide financial transactions. They will wait precisely as long as necessary and will likely embark on their global expansion better prepared than their Western competitors.