The Reserve Bank of India (RBI) is reportedly working on a phased implementation strategy for its own digital currency, with plans to launch it in wholesale and retail segments. The move comes after a high-level inter-ministerial committee recommended the introduction of a Central Bank Digital Currency (CBDC). The RBI is empowered under its current Act to regulate the issuance of bank notes.
Understanding Digital Currency
Digital Currency refers to a payment method which exists solely in electronic form, not physically. It can be transferred between entities or users using technology such as computers, smartphones and the internet. Despite being similar to physical currencies, digital money allows for borderless transfer of ownership and instantaneous transactions. Digital currency is also known as digital money and cybercash. Examples include cryptocurrencies like Bitcoin.
The Need for Sovereign Digital Currency
The need for a sovereign digital currency arises from the anarchic design of existing cryptocurrencies whose creation and maintenance lie in the hands of the public. This lack of government supervision and the ease of cross-border payments make them prone to malpractices like tax evasion, terror funding, and money laundering. Through the regulation of digital currency, central banks can put a stop to these malpractices.
Addressing Volatility of Cryptocurrencies
Cryptocurrencies are not pegged to any asset or currency, making their value subject to speculation (demand and supply). This has led to significant volatility in the value of cryptocurrencies like bitcoin. As CBDCs will be pegged to assets (like gold or fiat currency) they will not witness the same volatility observed in cryptocurrencies.
The Proxy Digital Currency War
India risks being swept into a proxy digital currency war as the US and China vie for supremacy in markets through new-age financial products. Today, the creation of a sovereign Digital Rupee is not just about financial innovation, but a necessity for combating potential threats to national and financial security.
Reducing Dollar Dependency
The Digital Rupee provides an opportunity for India to establish its dominance as a superior currency for trade with strategic partners, reducing dependency on the dollar. This is particularly important in the face of growing private currencies which pose a threat to national currencies with limited convertibility.
Significance of CBDC
A CBDC would bring numerous benefits including reduced costs of currency management and enabling real-time payments without any inter-bank settlement. Given India’s high currency-to-GDP ratio, the introduction of a CBDC could significantly cut costs associated with printing, transporting and storing paper currency. It would also mitigate public damage from the usage of private virtual currencies.
Key Issues and Legal Challenges
Several key issues are being examined under RBI’s purview, including the scope of CBDCs, the underlying technology, the validation mechanism and distribution architecture. Changes to existing legal provisions, made with physical currency in mind, will also be required under the Reserve Bank of India Act.
Recent Developments
El Salvador recently became the first country in the world to adopt Bitcoin as legal tender. The UK is also exploring the possibility of creating a Central Bank Digital Currency (Britcoin). China began testing its official digital currency, unofficially named “Digital Currency Electronic Payment, DC/EP”, in 2020.
Way Forward
The creation of a Digital Rupee will empower Indian citizens, enabling them to participate freely in the expanding digital economy and move away from the outdated banking system. Policymakers must carefully consider the impact of a Digital Rupee on the macroeconomy, liquidity, banking systems and money markets.
