New Delhi: India’s digital payments universe is set to get one more entrant in the form of a Central Bank Digital Currency. In other words, CBDCs could soon join Unified Payments Interface, or UPI, cheques, bank transfers, and debit and credit cards to transact with individuals and businesses.
In contrast to the dim view that the Narendra Modi government and the Reserve Bank of India (RBI) have taken regarding private cryptocurrencies, they have both been unequivocal in their commitment to introduce a central bank-issued variant of digital currencies.
In her Budget 2022 speech on 1 February 2022, finance minister Nirmala Sitharaman said that the introduction of CBDCs would give a “big boost to the digital economy”.
“It is, therefore, proposed to introduce Digital Rupee, using blockchain and other technologies, to be issued by the Reserve Bank of India starting 2022-23,” Sitharaman said in her speech.
The RBI, too, has been firm in its commitment to release CBDCs in a phased manner soon, with several senior officials having spoken about it in public. However, until recently, the RBI and the government have been pretty sparing with the details of how CBDCs will work, leading to a lot of speculation. It is a welcome move, then, that the RBI on Friday released a concept paper on CBDCs that addresses the majority of questions surrounding them.
In fact, the RBI has said that it will “soon commence limited pilot launches of e₹ for specific use cases”.
What are CBDCs?
The RBI defines CBDC as “legal tender issued by a central bank in a digital form”. In other words, it is digital cash. What makes it different from the conventional rupee when it is transacted digitally, say, in a UPI payment, is that CBDCs are based on blockchain technology. This lends CBDC transactions a level of transparency and security that surpasses even the pre-existing digital security India’s banking system has to offer.
As their name suggests, CBDCs are issued by central banks, which makes them very different from Bitcoin, Ether, and the plethora of other private cryptocurrencies. While private cryptocurrencies have no intrinsic value, the RBI’s CBDCs will be pegged on a 1:1 basis to the rupee—one rupee will equal one CBDC. What this means is that the price of CBDCs will not be hostage to the speculation that results in such intense volatility in cryptocurrency prices.
It also means that should anything go wrong with a CBDC transaction, the consumer will have the RBI to follow up with. At the moment, since cryptocurrencies in India have no regulation or body governing them, consumers have no regulatory recourse in the event of anything going wrong.
There are some fundamental prerequisites all CBDCs must have, the first of which is that they must appear as a liability on the central bank’s balance sheet in much the same way as any legal tender does. The CBDC must also be accepted as a medium of payment, legal tender, and a safe store of value by all citizens, enterprises, and government agencies. In other words, if you were to pay your local kirana store with CBDCs, they would be legally obliged to accept that payment at its face value, which is equal to the same rupee value. one CBDC will equal one rupee and nothing else.
Further, the CBDC would be fungible in the way that cash is–a hundred-rupee note is identical to any other for all practical purposes. In the same way, one CBDC will be the same as all others.
Additionally, CBDC users need not have a bank account. This is one factor that greatly differentiates CBDCs from the conventional rupee. To make digital payments right now, you need to have a bank account.
The RBI is planning to issue two different types of CBDCs based on their use cases. “CBDC can be classified into two broad types – general purpose or retail (CBDC-R) and wholesale (CBDC-W),” the central bank states in its concept note. “Retail CBDC would be potentially available for use by all private sector, non-financial consumers and businesses while wholesale CBDC is designed for restricted access to select financial institutions.”
So, while CBDC-W will be meant for the settlement of interbank transfers and related wholesale transactions, CBDC-R will be an electronic version of cash primarily meant for retail transactions.
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Why is the RBI thinking of CBDCs?
The RBI has given a number of reasons why it is developing a CBDC — optimising digital currencies, reducing costs associated with physical cash, and mitigating the destabilising effects of increased adoption of private cryptocurrencies, among others.
“CBDC affects the overall value of the money issuing function to the extent that it reduces operational costs, e.g. costs related to printing, storage, transportation and replacement of banknotes, and costs associated with delay in reconciliation and settlement,” the RBI concept note says, though acknowledging that the initial setup costs will be significant.
The RBI is clear in its note that CBDCs are not expected to substitute other modes but to supplement them. The development of CBDCs is meant to be another step in the move towards digitisation and a less-cash economy.
“As has been the experience with many payment products, once CBDC is introduced, innovations around the product would only expand the choices available and healthy competition will help bring about both cost and time efficiencies,” the RBI’s note said.
Another advantage of CBDCs over conventional digital transactions comes from the blockchain infrastructure, which makes CBDC payments final and instantaneous. This reduces the settlement risk, where money has gone from your account but not reached the receiver. This is of particular importance in a system in which inter-bank payments are so common — where the sender and receiver accounts are in two different banks.
“It can be compared to a cash-based transaction, where, instead of banknotes, CBDC is handed over leading to instant settlement. This is expected to bring in further efficiency in the payment system,” the RBI notes.
Finally, the RBI’s understanding that the CBDCs could become a risk-free alternative to private cryptocurrencies misses the underlying attraction of private cryptocurrencies—quick and huge profits that ride on volatility. This lure is missing from a CBDC since they are inherently as stable as the fiat currency.
Some more challenges
While the RBI’s concept paper does go into the basics of the ramifications of CBDCs on monetary policy, liquidity management, and monetary variables, it does not go into the details of how these would be managed.
With CBDCs being identical to cash in all respects except the medium, the RBI will have to do its currency management on a dual basis. Currently, the RBI issues more rupees with an eye on the inflationary effect of such a move. If CBDCs become popular, the RBI will have to manage its rupee printing in close coordination with the number of CBDCs it issues and address the inflationary impact of both.
There needs to be more discussion on how this would work. The same holds true for other monetary ratios such as the Cash Reserve Ratio, Statutory Liquidity Ratio and more.
This article is part of ThePrint Feature’s Tracking Cryptonomy series. Read all the articles here.
(Edited by Humra Laeeq)