China weighs up options on Libra

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.

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 RMB – or a competitor. In ANZ Research’s opinion, it’s too early to rule out the former.

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 - potentially 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 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 IMF’s 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 view 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 is still the preferred currency for accounts receivable as they need to naturally hedge their payable positions. $US/CNY trade still comprise up to 96 per cent of all spot transactions on CFETS.

Thus, 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:

• it is built on a secure, scalable, and reliable blockchain;

• it is backed by a reserve of assets designed to give it intrinsic value; and

• it is governed by an independent Libra Association consisting of 100 members tasked with evolving the ecosystem.

Facebook’s goal is to launch Libra by the first half of calendar 2020. The members will be from private institutions instead of governments.

Types of cryptocurrencies

Source: Media, ANZ Research

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.

Linked

In the Bretton Woods regime, the $US was pegged with gold at $US35/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 the 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’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.

Hypothetical price of Libra in CNY (on September 30)

Source: ANZ Research

Offshore holders of Libra will come potentially from less-developed countries with little access to the $US 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.