RBI’s Digital Currency Schemes

the story So Far: In the Budget presented for 2022-23, Finance Minister Nirmala Sitharaman had announced the launch of India’s Central Bank Digital Currency (CBDC) and that the digital rupee would give a ‘big boost’ to the digital economy. It had indicated that technologies such as blockchain would be used by the Reserve Bank of India for currency issuance starting from 2022-23. The Reserve Bank had indicated in July 2021 that it would soon start work on a ‘phased implementation’ of the CBDC.

What is Central Bank Digital Currency?

A CBDC is no different from the cash we keep in our wallets, except that it exists in a digital form. The CBDC will be held in a digital wallet that will be supervised by the central bank. In India, it will be the RBI that monitors the digital rupee, although it may delegate some power to banks. However, it appears that the RBI will take steps to encourage the use of its digital currency over physical cash. It is to be noted that RBI’s digital rupee will not directly replace the demand deposits kept in banks. Physical cash will continue to be used by banks, and those who wish to withdraw cash from banks can still do so. But they can also choose to convert their bank deposits into the new digital rupee.

Why are central banks issuing digital currency?

Central banks claim that there is a growing demand for digital currencies, which they seek to satisfy. They point to the rise of private digital currencies such as bitcoin and the increasing use of digital payments as examples of this secular trend. Central bank digital currencies are promised as a reliable, sovereign-backed alternative to private currencies that are volatile and unregulated. However, critics note that the demand for private currencies mainly comes from people who have lost faith in fiat currencies issued by central banks. He argues that governments around the world are devaluing their respective currencies by printing excessive amounts of them, thus forcing many to switch to private currencies whose supply is limited by design. He believes that a mere digital version of a national currency such as the rupee or the US dollar is unlikely to affect the demand for private currencies.

Central banks also recognize that the cost of issuing a digital currency is far less than the cost of printing and distributing actual cash. RBI can manufacture and distribute the Digital Rupee at almost zero cost as the creation and distribution of Digital Rupee will be done electronically. Another possible reason for the introduction of digital cash could be to reduce the use of physical cash. Unlike physical cash, which is harder to trace, a digital currency that is monitored by the RBI can be more easily tracked and controlled by a central bank. However, this feature of digital currencies has raised various concerns about their privacy and may slow down their adoption. In fact, it is worth noting that the need for privacy has been one of the primary reasons behind the switch to private digital currencies.

Are CBDCs becoming common around the world?

It is worth noting that many countries, including the United States, the European Union, and China, have been seriously working towards issuing their own central bank digital currencies (CBDCs) in recent years. In October 2020, The Bahamas launched the world’s first CBDC. However, some countries, including Finland and Denmark, have taken a step back and said they have scrapped efforts to introduce a digital currency, according to CBDCtracker.org.

In a 2017 note, Denmark’s central bank indicated that “it is unclear what central bank digital currency will be able to contribute that is not already covered by current payment solutions.”

It added that the potential benefits of introducing a CBDC in Denmark “were not assessed to match the considerable challenges faced by this introduction.”

What are the risks in adopting digital currencies issued by central banks?

Many, including various central bankers, fear that people may start withdrawing money from their bank accounts as digital currencies issued by central banks become more popular. This concern was also flagged by the Deputy Governor of RBI. Remember that many people currently use bank accounts to store their cash securely. When the digital wallet introduced by RBI can serve the same purpose, people can start converting their bank deposits into digital cash.

One thing that may prevent any major flight of capital from bank accounts to digital currencies is that bank accounts, unlike digital currencies, offer interest on deposits. But in developed economies, where interest rates are close to zero or negative, the risk of withdrawing money from people’s bank accounts and into digital currencies is real. This may not be of immediate concern to banks in India which still provide returns to their depositors in positive, at least nominal terms.

Withdrawals of bank deposits can also affect the amount of loans banks can make. However, this cannot happen just because banks will have less cash to lend to borrowers. Contrary to popular belief, banks do not lend to actual cash deposits. Instead, they use cash deposits as a basis on which they form a pyramid of electronic loans far more than cash deposits. So banks keep small amounts of cash in their vaults, which their depositors and borrowers can ask for anyway. The real reason banks will be able to make less loans is that when customers convert their bank money into a CBDC, banks will be forced to surrender at least some cash and thus have a smaller basis for making loans. . Also, when bank customers convert their deposits into digital rupees, RBI will have to take these liabilities off the banks’ books and on their balance sheets.

what lies ahead?

There is already speculation that central banks will cap the amount an individual can hold in the form of a CBDC. This is to prevent mass withdrawal of deposits from banks. Some even believe that some central banks, such as the European Central Bank, may impose negative penalties on their digital currencies. This may be done to force people to spend their digital currency and discourage withdrawal of deposits from banks that impose negative interest rates.

Central banks may have to inject fresh money into banks to ensure that banks’ ability to make loans is not affected by depositors’ digital currencies.

(With inputs from K. Bharat Kumar)