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Coming Soon: The Digital Rupee

The RBI, along with other central banks, is debating the use of a Central Bank Digital Currency. If safe and effective, it’ll challenge private crypto-currencies. But first, laws need to be amended to make this a reality.

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By Shivanand Pandit

As the legality of crypto-currency is vague, the Reserve Bank of India (RBI) is working on bringing out a Central Bank Digital Currency (CBDC). After four years of an inter-ministerial committee’s recommendation to launch fiat money in digital style, the RBI has said that preliminary plans to check its feasibility may be launched soon.

In fact, according to a study by the Bank of International Settlements (BIS), 86 percent of central banks all over the world are examining and researching CBDC and 60 percent are presently experimenting with it, while 14 percent are in the initial testing stage.

In India, RBI Deputy Governor T Rabi Sankar reportedly said that the central bank was working towards a phased execution plan for its own digital currency and would introduce it in the wholesale and retail sectors shortly. He also said that central banks have enhanced their care on digital currencies and their launching will help reduce the use of cash in the economy and lessen the harm to the public from the use of private currencies.

He further said that the RBI was scrutinising ways to reduce or remove disruption in India’s banking and fiscal systems. He said that legal modifications would be essential as present provisions had been made keeping in mind currency in the physical shape under the RBI Act. He said significant amendments would be needed in the Coinage Act, Foreign Exchange Management Act and Information Technology Act. Sankar said that crypto-currencies such as Bitcoin do not match the RBI’s definition of “currency”.

This is the main reason why the RBI, together with other central banks all over the world, is considering CBDC as a substitute to the volatile crypto asset in the conventional economy. CBDC curtails damages as it is not subject to market instabilities.

In 2017, a high-level inter-ministerial committee was established by the ministry of finance to examine matters about virtual currencies and recommend a plan of action. The committee’s report in 2019 focused on numerous risks linked with such private party, decentralised, virtual currencies comprising value fluctuation risks, absence of regulation, technology-related risks namely phishing, Ponzi schemes, illegal and criminal use such as terror funding and money laundering and stress on a nation’s resources. The report suggested CBDC, as well as the criminalisation of happenings surrounding crypto-currencies.

The genesis of statute-prohibiting crypto-currencies was also in the committee’s report.

The government’s opinion has constantly been that only a digital currency issued and controlled by the RBI would be accepted in India. Thus, CBDC is envisioned to be a form of digital currency issued by the RBI and approved by the government as legal tender. It is presumed that it will be secure, effective and hold persistent value unlike private crypto-currencies.

A CBDC has similar functions as a fiat currency and is transferable. The only difference is the form it takes digital. Private crypto assets such as Bitcoin and Ethereum have no legal issuers and cannot be seen as currency, whereas the CBDC is equivalent to any currency issued by a central bank except that it is in electronic form and will be reflected in the RBI’s balance sheet. 

The substantial upsurge in private crypto-currencies has been of concern to central banks all over the world and they pushed the case for official digital currencies. Many central banks have started experiments in this regard. Eastern Caribbean islands, such as Grenada, St. Kitts and Nevis, share a central bank and have already launched their own versions. The US Federal Reserve and the Bank of England are looking into possibilities for their economies. China has already had trial missions for its digital renminbi and is planning a major roll-out soon.

A CBDC can make all four functions of central banks in the payment segment more efficient. These are providing means of payment, finality of payment, liquidity to guarantee effortless settlement and systematic integrity and efficiency.

A CBDC will also drastically reduce the cost of printing, transporting and storing paper currency. It will also make inter-bank settlements vanish as it would be the central bank accountability handed over from one person to another. Foreign trade transactions too will be accelerated between nations.

A CBDC could permit an economical and more real-time globalisation of payment methods. It allows an Indian exporter to pay dues on a real-time basis without any intermediary. Moreover, the hurdles of dollar-rupee transactions and time zone differences in such transactions would evaporate.

Despite all these moves, the much-awaited Crypto-currency and Regulation of Official Digital Currency Bill, 2021, is yet to be introduced. The RBI needs to lay down guidelines about how the CBDC will be issued, the degree of secrecy it will have, the type of technology that is to be used and so on.

The RBI is evaluating whether CBDC should be at the retail or wholesale level of settlement. But if it is available for both payments, it will make a real difference. Even though China has suggested a hybrid model, the crucial issue for the RBI is whether the digital currency should be account-based or token-based. Also, deciding the scale of secrecy will be challenging. A CBDC could check private payment system providers from dominating transaction data through a self-reinforcing loop of data and network activities, attracting ever more users.

The RBI should carefully consider all probable influences of an official digital currency on people, the monetary policy and the system of banking. There are also other perils to be taken into account as well, including cybercrimes. More importantly, many laws need to be amended to make the digital rupee a reality.

Also, should the CBDC be issued through a distributed ledger synchronised between the RBI and scheduled banks or a centralised ledger held by the RBI? Should each CBDC be validated and identified by a unique serial number or token? If not, how would validation be done? Should distribution be only through the RBI or via banks?

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CBDC may also put stress on the traditional banking system by lessening the volume of deposits. Also, more importantly, a CBDC may not be an interest-bearing instrument. Bank credit is backed by the volume of deposits and if a CBDC catches on, many people may shift away from deposits. This will decrease the availability of cash for bank credit, compressing net interest margins, and thereby influencing investment and growth. Also, in case a bank fails, there is the likelihood of immediate withdrawal by customers. So the RBI should tactfully handle all these issues.

India has done remarkably well in digital payments in recent years. Interestingly, these have grown at an annual compound rate of 55 percent over the previous five years. Nonetheless, the digital rupee is a completely new element.

Setting up a digital currency will need cautious calibration and a proficient execution. Drawing board discussions and stakeholder consultations are significant. Notwithstanding all the obstacles inherent in launching the digital rupee, it will definitely be future money.

—The writer is a financial and tax specialist, author and public speaker based in Margao, Goa

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