In response to Moscow's invasion of Ukraine in February 2022, several countries, led by the United States, have imposed multiple economic sanctions against Russia. Such measures include disconnecting seven major Russian banks from the SWIFT payment messaging network, denying Russia access to international capital markets, and freezing the Russian central bank's reserves of around $630 billion.
While these actions have significantly impacted the Russian economy, they've also triggered discussions about central bank digital currencies (CBDCs) and their growing relevance across the global economic landscape. As countries have begun to develop their CBDCs, it's become essential to understand whether they can replace the existing system to bypass sanctions and other punitive measures. To further analyze these issues, we must look at how sanctions work, the growing international interest in CBDCs, and how sanctions can fit into this new system.
Sanctions and their effects
Several countries or entities have faced sanctions from the likes of the US or international bodies such as the UN and EU as deterring or punitive measures. Economic sanctions are often imposed against entities that violate international behavior norms or endanger national interests. They've often been used to advance foreign policy measures.
At present, the US can exert sanctions over countries due to the ubiquity of the dollar and its significant influence within the SWIFT (Society for Worldwide Interbank Financial Telecommunications) system, a vast messaging network of banks and financial institutions that oversees most international money and security transfers. The dollar's supremacy remains unparalleled as it is both – the leading reserve currency in the world and the principal currency in which most international transactions are conducted. Moreover, all dollar transactions must necessarily go through the US financial system.
In the current sanctions levied against Russia, US banks are required to stop processing transactions involving the sanctioned Russian banks. The banks' access to SWIFT has also been barred, which has rendered them unable to communicate or transact with other member institutions, thus impacting cross-border transactions. In addition, the United States has effectively frozen Russia's central bank's assets worth billions of dollars.
Due to such measures, countries facing the US and EU sanctions have been particularly interested in CBDCs. Among such nations, China is the most notable example. China's central bank – the People's Bank of China (PBOC) – has been developing a hybrid CBDC model for years now. It has completed multiple trials across major cities to launch the digital yuan or e-CNY. Pilots under the mBridge Project have also successfully made cross-border settlements with Hong Kong, Thailand, and the United Arab Emirates. Moreover, officials of the PBOC had announced that as of October 2021, about 140 million people had opened digital wallets for China's digital yuan and used it for transactions totaling about 62 billion yuan (nearly $10 billion).
Other countries that are both facing US sanctions and developing their CBDCs own include Venezuela, Iran, and Russia. While Iran is still in the process of conducting research, Venezuela's President Nicolas Maduro has tried to enforce the Petro coin – which is primarily seen as a failure. However, Russia is making progress with their CBDC, the digital ruble. Authoritarian regimes usually lay the groundwork for their CBDCs by attempting to limit the use of all other cryptocurrencies, and Russia’s central bank is no exception, having called repeatedly for a wholesale ban on crypto trading, mining and spending. On the 16th of February 2022, the Bank of Russia initiated the pilot stage of the digital ruble, just days before the invasion of Ukraine began.
All of these sanctioned countries would prefer to see the dollar lose its status as the world's primary reserve currency. One of the biggest concerns from the West regarding these developments is that if CBDCs are adopted as a new financial network, they may provide an alternative to the dollar settlement system and SWIFT. In such a future scenario, CBDCs could be used to circumvent many types of economic and financial sanctions imposed against countries by the likes of the US or EU This, in turn, could lead to global security risks, illicit transactions, and questions regarding the effectiveness of sanctions.
The Russia-Ukraine Conflict and CBDCs
Following Russia’s attack on Ukraine, the coordinated sanctions by the West have directly affected Russia's economy. The ruble initially lost 40 percent of its value and was saved only by the Russian government’s strict capital controls, preventing holders from selling off their rubles for other currencies. The stocks of Russian companies have fallen, and inflation jumped by 9 percent and is expected to rise further. Moreover, the Russian Central Bank immediately increased its interest rate to 20 percent in response to the situation, thus making it harder to take loans. Additionally, companies like Boeing Co., McDonald's Corp., etc., have pulled back from Russia, which would lead to further unemployment and inflation.
These measures – sanctions on finances and trading, banning exports, as well as travel bans have isolated Russia's financial system from the world. While Putin has acknowledged the devastating impact of these sanctions on the Russian economy, they haven't had any political impact on the ongoing conflict.
In fact, it seems that the Bank of Russia anticipated such a situation. In January 2022, it had proposed a ban on cryptocurrency but has accelerated efforts to develop a CBDC and even a domestic alternative to SWIFT called the System for Transfer of Financial Messages (SPFS). Recently, Russia's lower house of parliament, the State Duma, has approved a resolution calling for the Digital Ruble – which will be issued digitally by the Bank of Russia and be designated as a reserve currency.
While Russian lawmakers have been looking for ways to circumvent financial penalties imposed by the West due to the ongoing war with Ukraine, Russia has engaged in various efforts to reduce its reliance on the dollar over the years. To this end, the SPFS system could also become integrated with China's Cross-border Interbank Payment System (CIPS). Although these systems have a long way to go before competing with the long-established SWIFT, their development is part of the countries' 'de-dollarization' efforts.
The West’s concerns over Russia's advancements with the digital ruble become more significant when the United States' comparative lack of progress with CBDCs is brought into view.
One shouldn't ignore the possibility that with the development of CBDCs worldwide and the launch of Russia's digital ruble or China's digital yuan, the countries could perhaps bypass the US and EU sanctions. If foreign transactions were to be made via the e-CNY or the digital ruble instead of the dollar or through the SWIFT system, CBDCs could strongly affect the effectiveness of sanctions.
However, we must note that this situation might seem far-fetched in the immediate scenario. As long as 40 percent of the world's international payments are in dollars, the current system would be hard to replace.
Can CBDCs be designed with economic sanctions in mind?
Considering the global interest in CBDCs, there are unresolved concerns regarding the various CBDC models. However, one can make assumptions about the long-term impact of digital currencies or electronic payments based on the CBDC models being developed worldwide.
These different CBDC prototypes can be divided into two broad categories – country-specific CBDCs issued by corresponding central banks or a universal CBDC issued by a global multilateral institution. In the case of country-specific CBDCs, the central banks would only allow these currencies to be transmitted and exchanged within their jurisdictions. To enable cross-border transactions, central banks would have to allow intermediaries from different countries to hold an account denominated in the local CBDC.
Another such arrangement could be that central banks allow these currencies to be exchanged beyond their jurisdiction. This would work by enabling intermediaries to hold an account with the central banks but with CBDCs from other countries.
However, in the case of Universal CBDCs, they are accepted by all participating central banks. Converting local currencies into this universal CBDC will be based on an exchange rate either fixed by the central banks, much like the current system. Thus, payments can be made by converting the local currencies of the payer into the universal CBDC and again into the beneficiary's local currency.
We can say that if CBDCs were to replace fiat currency and establish a new system, it could also have far-reaching consequences for foreign policy and the effectiveness of sanctions. Say, if China no longer relies on SWIFT. In such a scenario, if it attempts to annex Taiwan and its navy begins a blockade of the island, any sanctions imposed on it by the US, EU, or other bodies wouldn't have the same economic effect on it. All foreign transactions could be made using the digital yuan or payments systems like the CIPS.
While such a situation could seem far-fetched, it can be possible if we consider sanctioned countries' de-dollarization efforts. As with any promising technology, the potential for misuse must be considered. There's a possibility that bad actors or aggressors can use CBDCs to evade sanctions and other punitive measures. Therefore, it becomes crucial to think about restrictive measures or sanctions that can work to prevent escalated conflicts and security threats in the era of CBDCs.
Possible solutions
In the present system, sanctions target countries or organizations by restricting their access to international transaction networks such as SWIFT. This will not remain sustainable in a CBDC-based financial infrastructure.
In the case of a country-specific CBDC, any sanctions might target the central bank, similar to how current sanctions have been imposed against the Russian Central Bank. But this step wouldn't be feasible since the international monetary and financial system is dependent on the cooperation of major central banks, and such restrictions can be easily bypassed.
However, if one were to consider a universal CBDC issued by a global multilateral institution like the SWIFT, the central organization could prevent the misuse of funds or impose punitive measures against aggressive actions. For instance, freezing a country's assets when it begins an unprovoked attack or when it attempts to annex a neighboring region. Such an organization could use its power to regulate cross-border transactions and exchanges, check security threats, and maintain a sense of global harmony. To this end, SWIFT has been looking for ways to integrate itself within the CBDC-based system. Of course, the question of who will be in charge of such a system and how it will operate is another question, one that we will discuss in another article.
List of sources
Academic
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Dostov, Victor, Pavel Pimenov, Pavel Shoust, Svetlana Krivoruchko, and Victor Titov. "Comparison of the Digital Ruble Concept with Foreign Central Bank Digital Currencies." 4th International Conference on Blockchain Technology and Applications, pp. 70-75. 2021.
Lee, David Kuo Chuen, Li Yan, and Yu Wang. "A global perspective on central bank digital currency." China Economic Journal 14, no. 1 (2021): 52-66.
Nölke, Andreas. "Geoeconomic infrastructures: Building Chinese-Russian alternatives to SWIFT" Goethe-Universität Frankfurt am Main, 2021
Rodriguez, Joshua. "The e-CNY: Implications of China's Digital Payment Technology and Central Bank Digital Currency for a Dollar Dominated World." (2021).
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Internet
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