Digital Rupee: The CBDC Frontier For Payment Systems

The Union Budget 2022-23 has shed some light on the central government's approach towards cryptocurrency. While the Budget has acknowledged such digital assets, a hefty tax structure is proposed. In addition, Union finance minister Nirmala Sitharaman pitched the idea of a Digital Rupee, India’s very own Central Bank Digital Currency (CBDC).  

Does the introduction of such a CBDC make sense in light of the technological advancements in the payments space in India?   

Why RBI Is Cautious About Cryptocurrency 

The keynote address by T. Rabi Sankar, deputy governor of the RBI, in a conclave of the Indian Banks Association, makes a scathing assessment of where cryptocurrency fits within India’s monetary and economic framework. While noting that cryptocurrencies are neither currency nor financial or physical assets, Sankar believes that it is only a speculative asset working as a Ponzi scheme. These views were promptly echoed by RBI governor Shaktikanta Das, who cautioned against private cryptocurrencies. He highlighted that such cryptocurrencies threaten macroeconomic and financial stability and undermine its ability to deal with challenges on the two fronts. 

These comments reflect the central bank’s (also the monetary policy regulator) fears about cryptocurrencies. It is pertinent to mention that the Supreme Court scuttled the RBI’s earlier attempts to place an outright ban on dealing with cryptocurrencies in 2020. 

Digital Rupee: An Idea Whose Time Has Come? 

The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, was scheduled to be tabled for consideration in the last winter session of Parliament. The Bill’s objective was two-fold: making a facilitative framework for creating official digital currency and probation of all private cryptocurrencies in India. The government has also received a proposal from the RBI to enlarge the definition of 'bank note' and include currency in digital form.  

Historically, money is usually issued by a sovereign. Although private currencies have existed, it has given precedence to sovereign money since a sovereign-backed public currency has better credit standing and is thus more stable. A CBDC is to be understood in this context as legal tender issued by a central bank in digital form and exchangeable with fiat currency (although in a different form). 

Evidently, the RBI and the government are seeking to leverage the benefits of the underlying technology, also known as Blockchain or Distributed Ledger Technology. A 2021 survey by the Bank for International Settlements found that 86 per cent of central banks were looking into the contours of launching CBDCs. It is also likely that the rise of private cryptocurrencies and the associated risks of anonymity and threat to monetary stability have triggered central banks' interest to explore CBDCs. 

Money issued by the central bank exists in two dimensions – paper currency used in daily transactions, i.e., retail, and reserves held by commercial banks with the central bank to manage interbank settlements, i.e., wholesale. The retail segment where paper currency is primarily used would provide the platform for various interesting innovations and make central banks rethink the traditional ideas around monetary policy. This would require a unique ecosystem with a central bank managing the centralised payment system through electronic wallets from where the payment can be made.  

How Does CBDC Stack Up Against UPI? 

The wallet ecosystem is prevalent on the Unified Payment Interface (UPI) network, which Indians are familiar with. However, CBDC is distinguished because the central bank manages the infrastructure, and payment is made directly through money issued by a central bank (and not reserves of commercial banks). 

A centralised payment system would obviate the risk of any payment systems being concentrated with any private player. Further, such a system would minimize settlement risk since the entire system would be sovereign-backed. The current payment systems involve multiple gatekeepers and sets of jurisdiction-specific regulations. The present systems have often been slow, expensive, and even unreliable (the most recent example is Russia's cut-off from the SWIFT ecosystem as part of the sanctions for invading Ukraine). A CBDC-based network can result in real-time transactions and establish a globalised payment system with minimum transaction costs, increasing transparency and creating trust in the business environment.   

A digital currency would also enable programmable money, which could herald innovations in the public welfare system and financial inclusion when combined with India’s JAM trinity (linkage of Jan Dhan accounts, Aadhaar and mobile phone). For instance, the government could set an expiration date for spending grants provided by it and minimise any leakage or corruption by regulating where the grants could be spent (like education or housing). Digital currencies would also reduce logistical costs for the central bank, which are spent printing, transporting, storing, and distributing money. 

What Are The Risks? 

While digital currencies solve many problems, they also create many others. The disintermediation of banks in the payment system would have second-order consequences which need to be thought through carefully while designing such CBDC.  

It is feared that the sovereign backing of CBDC might result in people withdrawing balances from banks resulting in bank runs whenever they perceive the health of banks to be fragile. Loss of low-cost deposits would hamper credit creation, affecting margins and increasing the cost of credit, ultimately affecting the country's macroeconomic stability.  

Technology preparedness would determine the proliferation of digital currencies. The payment systems should handle the volume of transactions to be looked upon as a worthy alternative to the current UPI ecosystem. Further, there is also a need to ensure high cybersecurity standards and increase knowledge about cyber risks.  

Conclusion 

Thus, the idea behind CBDC is to provide a legal currency that has some of the benefits of cryptocurrencies, such as programmable money, increased transparency, reduction of logistical costs, without the downsides including anonymity and lack of control. At the same time, careful thought needs to be given to the design of this digital currency architecture. 

 Abhisek Mohanty is a fintech advisor and an in-house counsel at a financial services company. Shatakratu Sahu is an advocate practicing in New Delhi.

(Disclaimer: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.)