Decoding how RBI’s Digital Rupee will impact the Indian economy

During the budget session, Finance Minister Nirmala Sitharaman said that the Reserve Bank of India would begin issuing Digital Rupees, also known as Central bank Digital Currency, in 2022-23, giving a boost to India’s economy. The concept of “Central Bank Digital Currencies” (CBDC) has been around for a while and has gained adoption with the rise of Bitcoin and countries like China issuing their own digital currency known as Digital Yuan to compete with the US Dollar on a global scale.

The notion of digital money has only been publicly explored by central banks, economists, and politicians in the past decade. CBDC is a digital or virtual currency, but it differs from the private virtual currencies that have proliferated in the recent decade.

Private virtual currencies are diametrically opposed to the traditional understanding of money. They are neither physical commodities nor generally claims on commodities since they have no inherent value; some assertions that are similar to gold seem to be purely speculative. They usually do not reflect any person’s debt or obligation unless they qualify as security tokens under respective regulatory frameworks.  

Although the benefits of global settlements may be realised if both nations in a currency transaction have CBDCs, the advantages of issuing a CBDC  may be sufficient to warrant India issuing one. Cash remains the preferred mode of payment and for receiving money for regular expenses. According to a Reserve Bank’s pilot survey on individuals’ retail payment habits in six cities between December 2018 and January 2019, cash is most often used for small-value transactions averaging 37,000 INR.

Also Read | Indian Union Budget 2022: Digital rupee to be introduced, virtual assets to be taxed at 30%  

It is critical to understand that CBDCs may reduce transaction demand for bank deposits, depending on the degree to which they are used. Because transactions in CBDCs lower settlement risk, they also minimise transaction liquidity requirements such as intra-day liquidity. Furthermore, offering a truly risk-free alternative to bank savings may encourage a movement away from bank deposits, reducing the need for government deposit guarantees.

On the other hand, reduced bank disintermediation comes with its own set of institutional risks. If banks start losing deposits over time, their capacity to provide credit is hampered. Because central banks are unable to lend to the private sector, the influence on the function of bank lending must be carefully considered in the context of the Indian economy. Furthermore, when banks lose considerable amounts of low-cost transaction deposits, their interest margins may be strained, resulting in a rise in lending costs which may impact the Indian economy at large. As a result of the possible costs of disintermediation, it is critical to design and operate CBDC so that demand for CBDC is controllable compared to bank deposits.

The accessibility of CBDC makes it simple for depositors to withdraw funds if a bank is experiencing difficulties. Deposits may be made considerably more quickly than cash withdrawals. On the other hand, having CBDCs available may prevent panic “runs” since depositors know they may withdraw quickly. One outcome might be that banks are driven to keep a higher level of liquidity, resulting in poorer profits for commercial banks with reduced lending capacity.

Understanding the Digital Rupee and the Indian Monetary Policy
 
CBDCs have the potential to affect the behaviour of the general public and the Indian economy at large. If demand for CBDCs exceeds supply and CBDCs are primarily issued via the banking system, as is expected, additional liquidity may be required to compensate for currency leakage from the banking system.

For this specific reason, much recent debate has focused on using negative interest-bearing CBDCs for monetary policy efficacy because negative interest rates are ineffective due to the transition to cash. Many advanced countries have been limited in their capacity to cut interest rates due to the exceptionally low inflationary economy. If money can carry a negative interest rate, the monetary transmission of negative policy rates to increase demand would be more successful. As a result, the case for paying a negative interest rate on CBDC as an unorthodox monetary policy instrument to encourage consumption is made. Any instrument that pays interest positive or negative is technically not a currency; hence such measures should be handled with caution as they may impact the Indian banking system. Interest-bearing CBDCs can impact the attractiveness of fixed deposits held by banking, negatively impacting Indian banks’ lending capacity.

Understanding Digital Rupee and its Technology Risk

Digital Rupee’s technical ecosystem may be vulnerable to cyber-attacks in the same way that present payment systems are. Furthermore, the rise in digital payment-related scams may expand to Digital Rupee in areas with lower financial literacy levels. As a result, institutions dealing with Digital Rupee must ensure strong cybersecurity standards while also focusing on financial literacy.

The economy’s ability to absorb Digital Rupee is partly dependent on technological readiness. The development of a population-scale digital currency system depends on the advancement of high-speed internet and telecommunication networks and the availability of adequate technology for storing and transacting in Digital Rupee with the general public. Lower levels of technology adoption in underdeveloped areas in India may restrict the reach of the Digital Rupee and exacerbate existing inequities in access to financial goods and services.

User Privacy and CBDC: The trade-off for Indian Citizens

The condition in which an individual’s information is known exclusively to the person and is not shared with anybody else without the individual’s agreement is known as privacy. The data is supposed to be kept private when it comes to financial transactions and it is critical to understand privacy from a CBDC perspective:

1. Individual identity

This contains personal information like a person’s name, address, a unique identifier like Adhaar card, a Driving License, PAN Card, passport number, and so forth.

2. Transaction History of Individuals

This comprises details about all financial transactions and history. The financial privacy of Indian citizens is critical as it is sensitive personal data that needs to be protected. Further, it overlaps with Personal Data Protection law, making it essential that the Indian CBDC architecture has enough safeguards to protect sensitive data for national security purposes.

3. Data about the transaction’s metadata

The information linked with a transaction might take many different forms depending on the kind of transaction. For example, the time of the transaction, the name of the transactors, the specifications of the products transferred within the transaction, the transactors’ location, and so on may all be found in the metadata of a credit-card transaction.

The preceding definition of privacy is significant because, with a technology-based CBDC implementation, the Central Bank’s and, by implication, other governmental agencies access to the aforementioned fields will be considerably more complicated than it is now. The government may carefully monitor the public by tying an individual’s financial information to their identity, which is a trade-off that Indian citizens would have to adapt to in the long run and forgo individual financial privacy.

Aside from the definition mentioned above of privacy, this article posits that a CBDC implementation may result in the entire abolition of fiat money in the long run, posing the Privacy conundrum. CBDC, unlike regular banknotes, allows payment devices to collect different information and data associated with payments and transactions. By using technology such as blockchain, the privacy concerns of the data-driven CBDC might be alleviated. On the other hand, many people believe that establishing CBDC would provide the law department with additional options for dealing with money laundering and tax evasion. For example, one of the benefits of the newly released Chinese CBDC is the avoidance of tax evasion. This may help the Indian economy as it may increase tax collection at the cost of individual financial privacy.

Decoding the Indian Legal Framework for CBDC

Although CBDCs are essentially identical to banknotes, their adoption would need the creation of an appropriate legal framework since present legal rules are written with paper money in mind. The Reserve Bank of India is authorised by the Reserve Bank of India Act, 1934, to “...control the issuing of banknotes and the holding of reserves with a view to maintaining monetary stability in India and generally to manage the country’s currency and credit system to its benefit” as stated in the preamble of the act. Various provisions of the RBI Act provide the Reserve Bank with the appropriate legislative authorities, such as those relating to denomination under Section 24, banknote shape under Section 25, legal tender status under Section 26(1), etc. Other Acts, such as the Coinage Act of 2011, the FEMA Act of 1999, and the Information Technology Act of 2000, may need substantial revisions. Even though CBDCs will be largely a technology-driven product, making the law technology-neutral to encompass a wide range of technological options will be preferable.

Conclusion

Digital Rupee’s implementation has the potential to deliver major advantages, such as less reliance on cash, increased seigniorage owing to lower transaction costs, and reduced settlement risk. CBDC might lead to a more reliable, efficient, trustworthy, regulated, and legal tender-based payment solution. There are risks involved, to be sure, but they must be carefully weighed against the possible advantages.
 
In the future, CBDCs are expected to be a part of any central bank’s armoury. Setting this up will need careful calibration and a sophisticated execution strategy. Stakeholder interactions and considerations on the drawing board are critical for designing a CBDC with a net positive impact with minimum technology risk. The relevance of technical difficulties when developing CBDC cannot be overstated as it will impact national economies and monetary policy. 

(Disclaimer: The views of the writer do not represent the views of WION or ZMCL. Nor does WION or ZMCL endorse the views of the writer.)