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Before RBI launches digital rupee, it must clear for Indians what the incentives are

RBI should be mindful of four key aspects as it lays the foundation for a digital rupee architecture.

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In her 2022 Budget speech, Finance Minister Nirmala Sitharaman announced that the Reserve Bank of India is on track to launch a digital rupee by 2023. Soon after, RBI Governor Shaktikanta Das clarified that there is no difference between the digital rupee and its physical counterpart, from a money supply-side perspective.

However, a digital rupee introduces two new features from the money demand-side. One, it will give individuals an option to split their savings and transactions into physical and digital currency. Two, it will increase the speed of these transactions, based on the extent individuals replace physical rupees with digital equivalents.

In both cases, the nature of this split between physical and digital remains unknown, triggering two key questions. First, what consequences will the unknown nature of this split have on India’s monetary health? Second, what can the RBI do to mitigate the associated risks with this undetermined split?

Monetary landscape and physical-digital rupee split 

Consider that you have a physical note of Rs 2000, with which you want to buy a product that costs Rs 200. But the shopkeeper refuses to go ahead with the transaction because returning Rs 1800 is inconvenient for them. Even if the shopkeeper uses a digital payment instrument, the deal won’t go through if you and the shopkeeper use different digital payment service providers. These examples indicate that acceptability is a prerequisite in a transaction network to make a payment. The forthcoming digital rupee will also be subject to this acceptability test, suggests the September 2021 report of the Bank for International Settlements (BIS).

There are two additional liquidity-related complexities which the digital rupee is likely to face. First, RBI deputy governor T. Rabi Sankar flagged concerns of money laundering, terror financing, tax evasion, etc. with private cryptocurrencies, in a speech delivered last month. A transaction tracking feature will have to be built in the digital rupee to address these concerns. A recent Ernst and Young survey suggests that, since individuals are concerned about their privacy, such a feature runs the risk of reducing transactions.

Second, “future usefulness to users” will be an important factor for citizens to adopt a digital rupee, according to the BIS report. This implies that, relative to physical rupee or any other monetary instruments, a digital rupee should offer an edge as a store of value. The most likely scenario is a seamless conversion of digital rupee into appreciative assets, which include precious metals, vehicle currencies like the dollar, and cryptocurrencies. It will bring about a considerable correlation between the demand for digital rupee and investor appeal for appreciative assets.

Therefore, while the RBI is building the digital rupee architecture, it must consider key issues of acceptability in a transaction network and individuals’ sensitivity to transaction tracking


Also read: Will RBI’s digital rupee be a hit? Well, there are so many ifs and buts


Digital rupee in the network of options 

The method of backward induction presents a cogent way to think of digital rupee adoption scenarios in future. Backward induction is the process of reasoning backwards in time, from the end of a situation, to determine a sequence of optimal steps.

Consider that there are only three payment instruments – a physical rupee, digital payments and a digital rupee. The scaled adoption of a digital rupee in future would mean two things. One, individuals are switching from physical rupees and digital payments to a digital rupee to carry out their transactions. Two, overall transactions in the economy have increased, with an abundant traction on digital rupee.

The first scenario can be conveniently situated in the present economic landscape. According to a report published in ThePrint in November 2021, digital channels and formal finance have made large inroads into a traditionally cash-dominated economy. So much so that the size of the formal economy has increased from around 50 percent to over 80 percent between 2017-21, predominantly due to an increase in the use of digital payment instruments. Digital payment transactions witnessed a growth of close to 90 percent in the three years from FY19 to FY21, as per a recent report.

On the surface, these statistics suggest that the impetus on financial inclusion are positive signs for the adoption of a digital rupee. However, digital payments thrive because of associated incentives like cashbacks and reward points. So, they are likely to retain their core traction and growth, because a digital rupee will lack similar features. This implies that most transitions will be from a physical rupee to its digital counterpart.

In the second scenario, a growth in overall transaction volume is plausible with sustained economic growth. The accrual of this transaction growth to digital rupee, physical rupee and digital payment instruments depend on how individuals prioritise one over the others. Physical rupee scores ahead of others in terms of anonymity, while digital payment instruments have embedded incentives that are seamless. What incentive will a digital rupee offer? If it floats into the economy just as a nominal substitute for a physical rupee, without any extra incentive, people will continue prioritising physical rupee and digital transactions over a digital rupee.


Also read: India’s plan to launch a digital rupee needs more thought, less haste


Policy lever

Unless digital rupee adoption has extra incentives relative to cash and digital payment instruments, it is likely that its demand will remain low and volatile. There are also concerns about its usage as a store of value, which may gravitate towards appreciative assets, including cryptocurrencies. While the RBI is considering pilot projects before the full-fledged launch of a digital rupee, it must focus on four core issues – the extent of and volatility in the demand for digital rupee, its store of value attributes, privacy concerns, and an individual’s preference for digital rupee over other payments instruments.

The author is Lead Economist at Koan Advisory Group, a technology policy consulting firm. He tweets @gautamvikash. Views are personal. 

This article is part of ThePrint-Koan Advisory series that analyses emerging policies, laws and regulations in India’s technology sector. Read all the articles here.

(Edited by Prashant) 

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