Digital economy in focus. India has announced plans to launch its own Central Bank Digital Currency (CBDC) this year. And along with this, India is in the race to introduce digital currency with many countries of the world. However, policy-makers still have a long way to go. Because, in this case, some things still need to be looked into.
Only when this is seen can proper shape of CBDC be given. Finance Minister Nirmala Sitharaman announced the launch of the Central Bank digital currency in the country during the presentation of the Union Budget last February. Addressing it as ‘Digital Rupee’, the Finance Minister claimed that its launch by the Reserve Bank in the current financial year will boost the country’s digital economy. Currency management system will become more efficient and cheaper.
But what is this CBDC?
The RBI says CBDC is “legal tender issued by a central bank in digital form. Much like fiat currency (currency issued by the government that does not have the form of gold or silver, but is issued by the government). Moreover, it is interchangeable with fiat currency.” Generally speaking, CBDCs are no different from national currencies. But only available in digital form. Therefore, unlike cryptocurrencies, the value of CBDC will not fluctuate over time.
But there is still a key difference between regular digital transactions and CBDCs that will set the digital rupee apart. Digital transactions through United Payment Interface (UPI) platforms such as BHIM, Google Pay or PhonePe involve the use of banking systems. Users need to link their bank accounts with UPI to make online transactions, whether it’s paying bills or transferring money…everything.
However CBDC will not involve banking system and it will have direct claim on central bank i.e. RBI in case of India rather than financial institutions.
Why central bank behind CBDC?
India is not the only one behind CBDC. Around 90 percent of banks around the world have opted for CBDC. A quarter of these are either trying to develop digital currencies or have pilot projects in place. The rate of central banks developing their own CBDCs has doubled over the past year, according to a Bank for International Settlements survey. These countries—including India—have increased their efforts to bring in CBDCs due to the growing rise of cryptocurrencies.
Basically the rise of stablecoins in the last few years. Moreover, the growing market of private cryptocurrencies has become a source of uneasiness. This has been a thorn in the road for central banks to become sole currency issuers. Hence, central banks are taking CBDC as a defense tool.
Stablecoins are not a ‘fork in the road’ crypto
The global perception in developed economies (about a year or two ago) was that (there is) not much usage of CBDC at this stage. Normal digital payment systems cannot achieve anything that a CBDC can. But with the introduction of stablecoins this has largely changed.” RBI Deputy Governor T Ravi Shankar made these comments at a webinar hosted by the Indian Council for Research on International Economic Relations in April.
Private cryptocurrencies were too volatile to function as currencies, he said, not seen as a ‘serious threat’ like stablecoins. This is where stablecoins, as the name suggests, have gained popularity among investors by providing price stability. Stablecoins, including Tether and USD coins, aim to maintain stability by being pegged to the value of another asset such as the US dollar or a commodity such as gold.
But what is certain is that India has a growing appetite for digital transactions. Thanks to the introduction of UPI for that.
How will CBDC help consumers?
So, the biggest question arises, if UPI which is the foundation of success of digital payments (widely used), then how will CBDC change the lives of consumers?
Shehnaz Ahmed, senior resident fellow and fintech lead at Vidhi Center for Legal Policy, said, “UPI is definitely the largest digital payment infrastructure. But CBDC will take that space into competition with its innovative model. It will appear to users like any other digital payment service. But since the CBDC will be a direct liability of the central bank, it will be more secure and will not rely on any defaults while routing money through bank deposits.
According to the 2018-2019 RBI survey, despite the growing use of digital transactions, cash is still the preferred mode of payment among the majority of the population. This is where CBDC can act as a true digital version of cash.
Since CBDCs will not be routed through banking channels, it can be as anonymous as cash, especially for small transactions. And in that sense, it can help RBI reduce the cost of printing and distributing currency notes. However, RBI is looking into the issue of benami in the case of digital rupees.
What is the biggest concern about CBDC?
Biggest fear of CBDC introduction: Dependence on the banking system will be drastically reduced. This means that customers will start keeping their money in their CBDC wallets and withdraw from bank deposits. If banks do not receive deposits, the ability to lend money to businesses and consumers will also decrease, and this may affect the economy and the banking system more broadly.
But Ahmed said that, while the central bank would take on the role of regulator in CBDC transactions, financial institutions could be made intermediaries – a model that some countries are now testing.
So far the Bahamas has become the first country to launch its CBDC, the sand dollar, in 2020, followed by Nigeria (eNaira) in 2021. The Eastern Caribbean and China have launched pilot versions of their CBDCs. In these countries, currency is stored in digital wallets and central banks have adopted a tiered-wallet system.
This means that low-value transactions will be anonymous and do not need to adhere to strict KYC norms But once the payment exceeds a certain amount, the transaction can be tracked. Daily transactions also have certain limits. This is done to check financial fraud and black money.
As for India, for now, the RBI is expected to release a white paper and phase-in pilot projects before going for the full launch of the digital rupee. The RBI is also looking into the use of CBDCs for the banking system or for cross-country transactions between two countries, known as wholesale CBDCs.
This can help reduce transaction settlement time. Because once a transfer is made through CBDC, it is immediate and does not have to wait for the central bank to complete the transaction. But this requires countries to work on a similar platform. RBI Governor Shaktikanta Das said in February that the central bank has taken a cautious approach. Will monitor the development of other countries in the field of CBDC.