China's plan to take its digital currency global may have found a potential launchpad: the wealth management sector in Hong Kong. Last month, the People's Bank of China issued detailed instructions regarding the "Wealth Management Connect" program, which will allow eligible individual investors in the southeastern regions of the mainland to invest a total of 150 billion yuan (23 billion dollars) abroad through banks in nearby Hong Kong and Macau. Residents in the two special administrative regions can invest up to the same amount in the opposite direction.
**Greater Bay Area**
While China and Hong Kong have similar channels for capital flows in both directions to stocks and bonds, this new arrangement is different: it applies only to investors and intermediaries in the so-called Greater Bay Area, which includes Shenzhen and eight other cities in Guangdong Province, along with Hong Kong and Macau. With a population of 70 million and a combined gross domestic product exceeding 1.6 trillion dollars, this integrated economic zone will be among the largest in the world.
**Digital Currency Testing Ground**
Pushing the digital yuan for asset purchases in this wealthy area could be an ideal testing ground. What will it take for wealthy investors to consider taxpayer-backed Chinese digital currencies as a safe store of value? Does the new currency need to offer interest? How much? Without eliminating broader capital controls and risking the financial stability of uncontrolled capital inflows or outflows, Beijing could find the answers. A successful experiment would boost global investor confidence in the digital yuan and may also provide a model for other digital currencies such as FedCoin, BritCoin, or the digital euro.
**Oversight of Financial Flows**
The strongest indication that China is considering such an experiment recently came from Sheng Yujing, director of the People's Bank of China's branch in Shenzhen. In an interview with Liao Wang magazine, Sheng suggested conducting a test to oversee cross-border financial flows between Shenzhen and Hong Kong, using the digital yuan as a conduit. The rationale for linking the two cities goes beyond geographical proximity and historical ties. The private sector drives the economy of Shenzhen, and its cross-border flows, mainly with Hong Kong, account for 7% of China’s total flows. Any speculative fallout could be easily contained. The legal status of the Special Economic Zone in Shenzhen, which fueled its rise as a global manufacturing power, could also be more easily adjusted from mainland regulations to include a unified rulebook: a bank allowed to conduct an activity in Hong Kong could engage in the same in Shenzhen and vice versa.
Sheng did not explicitly mention the Wealth Management Connect program as the "highway for financial innovation" she highlighted in her interview. However, using the digital yuan as a currency conduit for an experiment that is not limited to specific products but encompasses an entire platform, makes wealth management a strong candidate.
**Facilitating Daily Transactions**
So far, digital yuan trials have focused on its role in facilitating daily transactions, where Alipay and WeChat Pay dominate. Cautious of the influence of tech giants on Chinese consumer behavior, the state wants to reaffirm its control. Beijing can use the coercive power of laws and regulations to ensure the currency's success as a payment method.
But money must also function as a unit of account and a store of value. Challenging the dollar in trade invoicing will not be easy. The Chinese currency's market share of global payments is less than 2%, compared to 40% for the dollar. However, it should be feasible to encourage foreigners to hold more of their wealth in yuan. Beijing's previous attempt to secure the yuan as a store of value led to bank deposits in Hong Kong denominated in the currency increasing nearly tenfold in five years to nearly one trillion yuan in July 2015. Then came the currency devaluation shock, causing half of the deposits to vanish over the following two years, halting the yuan's internationalization project. But confidence has now returned.
**Challenging Dollar Dominance**
China's foreign exchange reserves have reached their highest level in five years, with yuan trading last month near its strongest levels since 2018. Allowing the wealthy to transfer some capital abroad may relieve pressure for the currency to rise. A greater role for market forces may persuade global investors that their returns will not be affected by a repeat of government interventions, as in 2015. The narrowing gap in volatility between the controlled domestic yuan and its more freely traded offshore counterpart shows that this confidence is beginning to take hold.
The digital yuan, which won’t be ready until at least the Beijing 2022 Olympics, may later need to join the Wealth Connect program train. This is good in itself. Currently, the digital yuan does not support smart contracts. Future releases may include self-executing program code intended to automate securities settlements and interest payments, reducing transaction costs for investors.
Beijing's desire to challenge dollar dominance is genuine. Utilizing the wealthy to fuel Hong Kong's launch and open the economy with the digital yuan may be the best way to approach this distant goal.
