Understanding the Strategic Environment around China’s Digital Currency

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China launched its Central Bank Digital Currency (CBDC) coined the Digital Currency/Electronic Payment (DC/EP) in April 2020, after a six-year research and development phase. Its launch was widely examined and reported, but there has been no significant piece on China’s experiment in the context of China’s economic status and international standing. This is what today’s blog post will explore. 

China’s Domestic Economy

In April 2020, China saw a 6.8% contraction in its economy, the first contraction since recording figures in 1992, largely as a result of the mass shutdowns and quarantines in the wake of the COVID-19 pandemic in late January. Analysts have predicted that this contraction negates the 6% expansion in China’s economy recorded at the end of 2019. 

China has had a persistent issue with non-performing loans (NPLs). In 2001, China had around 29.8% of gross loans considered defaulting loans, but by 2010 had managed to drastically reduce NPLs. NPLs rose yet again post-COVID, with reports suggesting that China’s $41 trillion banking system could suffer an $1.1 trillion increase in bad debt this year. June 2020 also saw two bank runs amidst fears of collapse at Chinese banks.

The DC/EP could potentially have an impact on NPLs, particularly in the manner in which NPLs are dealt with, if implemented at a full scale. This is explored in depth in our Report Series on China’s Digital Currency. 

Geopolitical tensions

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China has seen deteriorating relationships with several countries, and this has been compounded by the onset of the COVID-19 pandemic. The US and China have had a challenging relationship since the trade war beginning 2018. 

In 2018, the US imposed tariffs on $550 billion of Chinese products, and China subsequently imposed additional tariffs on $185 billion of US goods. The countries reached a deal, wherein China committed to purchase an additional $200 billion in US goods and services over two tears, remove barriers to various US exports, and the US agreed to suspend an additional 15% tariff on around $162 billion worth of imports from China and reduce some newly imposed duties.

Between 2018 and 2020, US-China tensions have dampened investor sentiment with the tariff battle eroding $1.7 trillion worth market capitalization of US listed companies. The COVID-19 pandemic further worsened diplomatic relations between the US and China, with the US accusing China of downplaying the severity of the virus and hiding the actual damage.

US-China tensions have now seeped into the financial sector with the US threatening to financially decouple China. Currency has itself become a bone of contention between the two countries. China has accused the US Government of weaponizing the dollar by leveraging the dollar’s global dominance to impose sanctions and ensure extraterritorial application of US law. The US has accused China of manipulating the yuan and intentionally lowering the value of the dollar-pegged yuan

Geopolitical tensions are not limited to the US, but also include the Quadrilateral Security Dialogue (commonly called the ‘Quad’) – an informal forum comprising India, Japan, Australia and the US. Both India and Australia have had clashes with China in the recent past. The India-China border dispute has severely soured relationships between the two countries, with several skirmishes on the Line of Actual Control between the two countries escalating tensions. Tensions between Australia and China rose in 2020 with Australia conducting an independent investigation into the origin and spread of COVID-19, and China targeting Australian exports to China in a retaliatory move. Japan has not been spared from tensions with China, with disputes regarding the East China Sea area around the  Senkaku Islands causing both countries to escalate military presence in 2020.  

The post-COVID era has seen multiple countries introducing regulations scrutinizing Chinese investments due to China’s attempts to acquire companies through distressed takeovers in a risk-off mode. 

Impact on Trading Relationships

Amid already deteriorating trading relationships, China has seen the COVID-19 pandemic worsen the global trade outlook. Countries are gradually deglobalizing, and this has a negative impact on the world and on China. While the idea began to take shape in 2019, the 2020 pandemic drove countries to retreat from global economic integration, severing supply chains and trade relationships. Globalization is in retreat for the first time since World War II. 

Both the US and China have had domestically-focused policies. China, under President Xi Jin Ping, has turned inward with policies to promote the indigenous development of leading industries. The US, under President Trump, embraced an “America First” policy, which saw a withdrawal from the Trans-Pacific Partnership and a shift away from trade liberalization and toward protectionism. 

China has nonetheless attempted to leverage its trading relationships cultivated by the Belt and Road Initiative. As of August 2020, China has posted a trade surplus, and its dollar-denominated exports rose by 9.5%.

The Role of the DC/EP

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On all these dimensions – domestic and global – the DC/EP plays a significant role. It could fundamentally shift currency dominance and could potentially change several trade-related processes. China’s global relationships are also key to the success of the DC/EP. These many dimensions of the DC/EP projects – monetary, economic, financial and geopolitical – have been examined in depth in our comprehensive 4-part Report Series on China’s Digital Currency. You can sign-up to be notified here.

Leave us a comment telling us what you think! And keep on the lookout for our next blog post coming soon. 

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