15 Jul 2019
Libra, the fledgling digital currency of social media behemoth Facebook, is encountering hurdles in its implementation which may not match the early hype. The departure of payment giants Mastercard and Visa from talks are a significant loss and founder Mark Zuckerberg’s appearance in front of US Congress seems to have raised more questions than it has answered.
But an even more-important player is yet to show its hand. For China, Facebook’s plan to create a blockchain-based digital currency could prove to be an enhancer for its plans around the renminbi (RMB) – or a competitor. In ANZ Research’s opinion, it’s too early to rule out the former.
"Blockchain offers a fungible asset class option for China’s reserves investment, one which can be relatively independent of political considerations.”
Since Libra’s reserve basket may exclude the RMB, an increase in the usage of the former will undermine the usage of the latter. The mainstream view in China is for the People’s Bank of China (PBoC) to develop a competing digital currency – which ANZ Research understands is underway.
However, ANZ Research holds a slightly different view. Blockchain offers a fungible asset class option for China’s reserves investment, one which can be relatively independent of political considerations.
As a stablecoin, Libra is backed by a basket of currencies. If China creates a digital convertibility standard, this could potentially lift the global acceptance of RMB - making it a landmark event comparable to the Bretton Woods system launched in 1944.
Paved the way
China appears to have paved the way for the development of a convertible standard linked to a basket of currencies.
In the onshore market, after the PBoC established a currency swap agreement with a country, CFETS (China Foreign Exchange Trade System) would add that currency to its trading platform, which currently includes the Euro, Yen, Hong Kong dollar, Australian dollar, New Zealand dollar and the Korean Won, among others. In the offshore market, the CNH (externally traded RMB) is freely convertible with any currency.
A complementary strategy is to increase the popularity of the Chinese yuan (CNY - internally traded RMB) assets. In recent years China has made some progress, convincing a few global benchmarks to include the RMB in their baskets.
In 2016, the RMB was added to the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) basket. In April, onshore CNY bonds were included in the Bloomberg Barclays Global Aggregate Index, a global bond benchmark. JPMorgan is also planning to add CGB to its bond indices from February 2020.
Nonetheless, the above efforts have not been successful in lifting the renminbi’s status to a similar level as the US dollar - a safe haven choice even in a zero interest rate environment, like gold.
Global investors are attracted by the higher yield of CNY in an opportunistic manner rather than viewing it as a wealth preserving option. Even though China is the world’s largest exporter and commodity buyer, the RMB is still not the default currency in trade invoicing.
Even among Chinese exporters, the US dollar (USD) is still the preferred currency for accounts receivable as they need to naturally hedge their payable positions. USD/CNY trade still comprises up to 96 per cent of all spot transactions on CFETS.
This means a digital currency offers a whole new realm for China to consider - and Facebook’s Libra could be a prominent contender.
Secure, scalable & reliable
According to the company’s white paper, Libra is a cryptocurrency with several features:
Facebook’s goal is to launch Libra by the first half of calendar 2020. The members will be from private institutions instead of governments.
ANZ Research understands China is developing its own version of digital currency which will be regulated by the PBoC. It is likely Chinese authorities will desire to preserve the sovereignty status of the Chinese currency in any form.
This domestic version will likely be a digital form of the RMB. If so, it will merely be a project on payment technology. This development will not introduce any breakthrough in China’s reserve management system.
In ANZ Research’s view, however, Libra and other similar stablecoins are consistent with China’s de-dollarisation. Initially, Libra can be regarded as an alternative asset class in the PBoC’s reserve portfolio.
Libra will immediately become a currency fund because it is backed by (but not pegged with) a basket of sovereign currencies. The overall basket seems to be consistent with the PBoC’s FX reserves portfolio.
According to Facebook, the Libra Association will appoint a geographically distributed network of custodians with investment grade rating to limit counterparty risks. Therefore, it can reduce the risk faced by other fiat-backed stablecoins, such as Tether.
Once Libra becomes a globally fungible tool independent of political considerations, the PBoC can consider a convertibility undertaking similar to that of the USD during the Bretton Woods regime.
This can be achieved by signing a swap agreement with Libra. Since Libra also is also backed by a basket of currencies, having digital convertibility means the RMB will remain in the fiat money regime. But blockchain technology will provide a shortcut for China to tap into the decentralised market.
In the Bretton Woods regime, the USD was pegged with gold at $US35 per ounce. In the digital era, CNY can be linked to Libra or a similar cryptocurrency.
Nowadays global gold reserves are not sufficient for China to establish a gold standard for the RMB. In addition, gold does not seem to be a working currency in the digital age.
Using the currency basket disclosed by Facebook it is possible to calculate the implied unit of other basket currencies in the backing portfolio. Unlike the HK dollar’s linked exchange rate system, the PBoC does not need to allocate a backing portfolio equivalent to 100 per cent of its monetary base as China adopts a managed floated regime instead of a currency board.
Offshore holders of Libra will come potentially from less-developed countries with little access to the USD via mobile technology. By replicating the idea, China can enhance the global acceptance of the RMB.
From this perspective, Libra can be a RMB-enhancer, not a competitor.
Raymond Yeung is Chief Economist, Greater China, Zhaopeng Xing is a China Markets Economist, Khoon Goh Head of Asia Research and Daniel Hynes is a Senior Commodity Strategist at ANZ
This story is an edited version of content which originally appeared in a note from ANZ Research. Click HERE to read the original note.
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
15 Jul 2019
26 Jun 2019