Earlier this year, India announced plans to have its own central bank digital currency (CBDC). Even as India has joined the race of the majority countries, when it comes to launching a digital currency, policymakers have a long road ahead as they need to examine some key issues that would give the CBDC its right shape. In February, during her Union Budget speech, Finance Minister Nirmala Sitharaman had announced introducing a CBDC for India. Calling it a ‘digital rupee’, Sitharaman emphasised that its launch by the Reserve Bank of India (RBI) in this financial year will boost the digital economy and lead to a more efficient and cheaper currency management system.
What is a CBDC?
The RBI has defined CBDC as a “legal tender issued by a central bank in a digital form. It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency.” In simple terms, CBDC is no different from a national currency, but is only in the digital form.
Hence, unlike cryptocurrency, CBDC’s value would not fluctuate over time.
But there is still a key difference between doing regular digital transactions and CBDC that would set the digital rupee apart. Digital transactions done through United Payments Interface (UPI) platforms such as BHIM, Google Pay, or PhonePe involve the use of the banking system. Users have to link their bank accounts with the UPI for doing an online transaction, whether it's for payments or transferring money.
However, the CBDC would not involve the use of the banking system and it would be a direct claim on the central bank, i.e. the RBI in India’s case, rather than the financial institutions.
Why are central banks exploring CBDCs?
India is not alone in exploring the CBDC. Close to 90 percent of central banks across the globe are involved in work related to CBDC and one-fourth of them are either developing their digital currency or are in the advanced stage of running a pilot already. The survey conducted by the Bank for International Settlements showed that the number of central banks developing their own CBDC has doubled in the last one year.
The reason for this growing interest among countries, including India, to develop a CBDC now more than ever is the rise of cryptocurrencies, and particularly the stablecoins, in the past couple of years. More than anything else, CBDCs are turning out to be defence mechanisms being adopted by central banks who have shown some discomfort with the idea of the growing market of private cryptocurrencies as it challenges their authority of being the sole currency-issuer.
Crypto not 'serious threat' to stablecoins
“The global thinking of advanced economies (about one-two years ago) was that (there is) not much of the use of CBDCs at this stage. Nothing that your normal digital payment systems cannot achieve that CBDC can. But this largely changed with the onset of stablecoins,” RBI deputy governor T Rabi Sankar said in a webinar organised by the Indian Council for Research on International Economic Relations (ICRIER) in April.
Sankar said that since private cryptocurrencies were too volatile to act as currency, they were not seen as serious a threat as stablecoins. This is where stablecoins, as the name suggests, gained popularity among investors by offering stability in value. Stablecoins, including Tether and USD Coin, aim to maintain a stable value by being linked to either the value of another asset such as the US dollar or a commodity such as gold.
To be sure, India has a growing appetite for digital transactions, with digital payments growing at a robust pace, by over 50 percent each year, in the last five years, thanks mostly to the introduction of the UPI.
How will CBDC help consumers?
So, the bigger question that arises is if UPI, which is the cornerstone of success in digital payments, is being used widely, how will CBDC change the life of consumers?
“UPI is definitely the biggest digital payment infrastructure but CBDC will lead to competition in that space through its innovative model. It will seem like any other digital payment service to users but since the CBDC will be a direct liability of the central bank, it would be more secure and not dependent on any sort of default which could arise when dealing with routing the money through bank deposits,” Shehnaz Ahmed, Senior Resident Fellow and Fintech Lead at Vidhi Centre for Legal Policy, said.
According to an RBI survey of 2018-19, cash still remains the preferred mode of payment for the majority of the population despite the growing use of digital transactions. This is where CBDCs can act as the true digital version of cash.
Since CBDCs would not be routed through the banking channels, it can offer the anonymity that cash also offers, especially for small-valued transactions. And in that sense, it can help the RBI to reduce the cost of printing and distributing currency notes.
The RBI is looking into the issue of anonymity for Digital Rupee by exploring whether such small-valued transactions could be ‘killed’ or if a new law would be required to restrict access to the data.
What’s the biggest concern around CBDCs?
And this is the biggest fear attached with the introduction of CBDCs: the dependence on the banking system will also reduce drastically. This would mean that consumers will start putting their money into their CBDC wallets and withdraw from bank deposits. If banks do not get deposits, then their ability to lend money to businesses and consumers would also reduce and that could have some effect on the economy and the banking system at large.
But Ahmed said that financial institutions could be made intermediaries, too, with the central bank taking the role of a regulator for CBDC transactions — a model that some countries are examining right now.
So far, the Bahamas became the first country to launch its CBDC, the Sand Dollar, in 2020, followed by Nigeria in 2021 (eNaira). The Eastern Caribbean and China have launched the pilot versions of their CBDCs. In these countries, the currency is stored in digital wallets, and the central banks have adopted a tiered-wallet system. This means that low-value transactions would be anonymised and do not require strict KYC norms compliance. But once payments cross a certain threshold, the transactions can be tracked. There are certain limits on daily transactions, too. This is done to keep a check on money laundering and black money.
In India’s case, for now, the RBI is expected to release a white paper and launch pilots in a phased manner before going in for a full launch of the Digital Rupee. The RBI is also exploring the usage of CBDCs for the banking system or for cross-country transactions between two countries, also known as wholesale CBDC. This could help in reducing transaction settlement time as once a transfer through CBDC happens, it is immediate and one would not have to wait for operational hours of central banks for transactions to get completed. But that would require countries to operate on similar platforms, which might be a time-taking process.
RBI governor Shaktikanta Das had said in February that the central bank is taking a cautious approach. Given how India has adopted a wait-and-watch approach in its plans to bring in a law for either banning or embracing cryptocurrencies, it will continue to keep an eye on developments in other countries when it comes to CBDCs.
The author is a business journalist who has reported on government policy and economy for prominent national and international publications in the past nine years. He was recently an Alfred Friendly-OCCRP fellow who worked for the LA Times in the United States for three months, reporting on the global economy and cryptocurrency.
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