Pacific Money | Economy
For countries like China, India, and Indonesia, CBDCs offer tempting solutions to several issues – including the dominance of the U.S. dollar.
The European Parliament just issued a report tapping the brakes on a central bank digital currency (CBDC), fittingly titled “Digital Euro: When in doubt, abstain (but be prepared).” In contrast, emerging economies like China, India, Indonesia, and Thailand have rushed to introduce CDBCs in the hope of greater financial inclusion and easier transfer of remittances. What explains the different approaches?
The rise of stablecoins and unbacked cryptocurrencies has started to undermine the effectiveness of central bank policies in several countries, and increased threats of money laundering and financing illegal activities. For these reasons, more than 150 countries have flirted with the introduction of a central bank digital currency, with a marked rush in Asian emerging markets to introduce concept notes and pilots. CBDCs are digital currencies that are issued by central banks, and their value is linked to the sovereign currencies or to standards such as gold.
For many emerging markets in Asia, CBDCs are also seen as a possible tool to combat the financial hegemony of the dollar. Many emerging economies are “cursed” with weak currencies. While engaging in international trade or securing corporate or government debt, emerging economies are forced to trade and borrow in U.S. dollars. This cripples them as they try to repay debt in dollars with a weaker currency. With CBDCs, emerging economies could circumvent the requirement to pay in U.S. dollars by directly transferring digital currencies in bilateral contracts.
But while CBDCs have been heralded as a magic wand, the reality is that CBDCs can also amplify economic shocks or adversely impact capital flow dynamics in emerging economies. Also, central banks have faced multiple challenges to execute and drive adoption of CBDCs in their markets.
In China, one of the first countries to introduce CBDCs, the adoption of the digital yuan (e-CNY) has failed to take off in line with its ambitious targets. Chinese authorities already have piloted the e-CNY, which was showcased at the Beijing Olympics in February 2022. During the event, adoption by athletes was robust because it made transactions cheaper and for the first time the Mastercard/Visa duopoly was broken. But domestically, adoption in retail payments has been lukewarm, pushing authorities to pull several levers.
The authorities have given away $26.5 million in e-CNY to drive usage, and popular mobile applications WeChatPay and Alipay recently began accepting digital yuan payments. Recently, the authorities in China have started paying salaries for city civil servants in digital yuan.
Currently, the e-CNY has surpassed 100 billion yuan (about $14.5 billion) in spending and is now included in official circulation data. The e-CNY wallet will be included in the popular mobile payments WeChat Pay and Alipay, which already have millions of users. Given the massive existing user base for these products, organic adoption of the e-CNY remains an uphill battle. Given the widespread use of existing digital payment services, many Chinese may see little additional benefit from converting to use of the e-CNY.
Should China succeed in driving long term adoption of the digital yuan, however, it could eventually challenge the U.S. dollar’s status as a favored reserve currency in some parts of the world.
In India, the Reserve Bank of India has piloted a CBDC (the e-rupee) in a “hybrid format”: a wholesale CBDC-W for financial institutions to improve interbank payments, and a retail CBDC-R for citizens. The e-rupee utilizes blockchain technology, but it faces challenges related to privacy and anonymity. Different options have been advocated, including allowing citizens to delete transactions on the blockchain to maintain anonymity. Another challenge remains adoption. The e-rupee will have to jostle for space with Unified Payment Interface (UPI)-enabled payment giants like Paytm and Google Pay.
From a global trade perspective, India has started building bilateral relationships for cross-border payments with countries that have a large Indian diaspora, such as Singapore, France, and the United Arab Emirates. India’s recent announcement that it will collaborate with the UAE to develop interoperable CBDCs could be a very real effort by emerging economies to trade directly without the U.S. dollar.
Indonesia’s Project Garuda kicked off in 2022 with the aim of introducing a digital e-rupiah in a hybrid format akin to the Indian e-rupee. In its concept note, Bank Indonesia (the country’s central bank) explicitly highlighted the recent rise of a “shadow currency” due to the rapid adoption of crypto assets outside the purview of the country’s sovereign jurisdiction. Bank Indonesia plans to supplement the digital rupiah with programmable features using smart contracts and allow tokenization of tradable securities.
However, Bank Indonesia will have to navigate lack of trust from users, who seem to view this new digital currency as another crypto product, as opposed to the “digital form of trusted money.” Indonesia also risks opening the floodgates to rapid inflows and outflows of foreign investments through real-time trading, something that could worsen its existing currency volatility woes.
For emerging economies, the ultimate goal is to find a way to stabilize the value of their currency and give financial access to the unbanked population. But as the examples above demonstrate, the mere existence of CBDCs will not alter global financial dynamics and its impact on weaker currencies. This is a fight to which emerging economies will have to bring multiple weapons – CBDCs will just be one of them.