Getty ImagesIn her Budget 2022 speech on Tuesday, Finance Minister Nirmala Sitharaman announced the Reserve Bank of India (RBI) will launch its own digital rupee in the new financial year. The Digital Rupee is a central bank digital currency (CBDC) that will be launched in 2022-23, the FM said.
Today, while presenting the Union Budget for 2022-23 in Parliament, she elaborated on how the introduction of Central Bank Digital Currency (CBDC) would provide a significant boost to the digital economy. “Digital currency will also lead to a more efficient and cheaper currency management system”, she said.
Here is a look at what is a CBDC and how it will work according the RBI.
What is a CBDC?
The full name of CBDC is Central Bank Digital Currency is a legal tender issued by the Reserve Bank of India (RBI). “CBDC is the same as currency issued by a central bank but takes a different form than paper (or polymer). It is sovereign currency in an electronic form and it would appear as liability (currency in circulation) on a central bank’s balance sheet. The underlying technology, form and use of a CBDC can be moulded for specific requirements. CBDCs should be exchangeable at par with cash,” according to RBI website.
What is a currency?
According to RBI website, “In modern economies, currency is a form of money that is issued exclusively by the sovereign (or a central bank as its representative). It is a liability of the issuing central bank (and sovereign) and an asset of the holding public. Currency is fiat, it is legal tender. Currency is usually issued in paper (or polymer) form, but the form of currency is not its defining characteristic.
What is the need for a CBDC?
While, there is a widespread interest in CBDCs, only a few countries have managed to progress beyond the pilot stage of developing their own CBDCs. According to RBI website, “A 2021 BIS survey of central banks found that 86% were actively researching the potential for CBDCs, 60% were experimenting with the technology and 14% were deploying pilot projects. Why this sudden interest? The adoption of CBDC has been justified for the following reasons:-
1. Central banks, faced with dwindling usage of paper currency, seek to popularize a more acceptable electronic form of currency (like Sweden);
2. Jurisdictions with significant physical cash usage seeking to make issuance more efficient (like Denmark, Germany, or Japan or even the US);
3. Central banks seek to meet the public’s need for digital currencies, manifested in the increasing use of private virtual currencies, and thereby avoid the more damaging consequences of such private currencies.”
CBDCs advantages over other digital payments system
“Payments using CBDCs are final and thus reduce settlement risk in the financial system. Imagine a UPI system where CBDC is transacted instead of bank balances, as if cash is handed over – the need for interbank settlement disappears. CBDCs would also potentially enable a more real-time and cost-effective globalization of payment systems. It is conceivable for an Indian importer to pay its American exporter on a real time basis in digital Dollars, without the need of an intermediary. This transaction would be final, as if cash dollars are handed over, and would not even require that the US Federal Reserve system is open for settlement. Time zone difference would no longer matter in currency settlements – there would be no ‘Herstatt’ risk," as per the RBI website.
Do we need CBDC in India?
India is leading the world in terms of digital payments innovations. Its payment systems are available 24X7, available to both retail and wholesale customers, they are largely real-time, the cost of transaction is perhaps the lowest in the world, users have an impressive menu of options for doing transactions and digital payments have grown at an impressive CAGR of 55% (over the last five years). It would be difficult to find another payment system like UPI that allows a transaction of one Rupee. With such an impressive progress of digitisation, is there a case for CBDCs?, RBI said.
“Given its dynamic impact on macroeconomic policy making, it is necessary to adopt basic models initially, and test comprehensively so that they have minimal impact on monetary policy and the banking system. India’s progress in payment systems will provide a useful backbone to make a state-of-theart CBDC available to its citizens and financial institutions", according to the Report of Trend and Progress of Banking in India 2020-21.
Small value transactions
There is a unique scenario in which the country's adoption of digital payments is accompanied with a continued interest in cash usage, particularly for small-value transactions. “To the extent the preference for cash represents a discomfort for digital modes of payment, CBDC is unlikely to replace such cash usage. But preference for cash for its anonymity, for instance, can be redirected to acceptance of CBDC, as long as anonymity is assured.” as per RBI website.
Cost of printing
Another advantage of CBDCs is India's high currency-to-GDP ratio. The cost of printing, transporting, storing, and distributing currency can be decreased to the extent that substantial amounts of cash can be substituted by CBDCs.
Advent of private virtual currencies (VCs)
“The advent of private virtual currencies (VCs) may well be another reason why CBDCs might become necessary. It is not clear what specific need is met by these private VCs that official money cannot meet as efficiently, but that may in itself not come in the way of their adoption. If these VCs gain recognition, national currencies with limited convertibility are likely to come under threat. To be sure, freely convertible currencies like the US Dollar may not be affected as most of these VCs are denominated in US Dollar. In fact, these VCs might encourage the use of US Dollar, as has been argued by Randal Quarles3. Developing our own CBDC could provide the public with uses that any private VC can provide and to that extent might retain public preference for the Rupee. It could also protect the public from the abnormal level of volatility some of these VCs experience. Indeed, this could be the key factor nudging central banks from considering CBDCs as a secure and stable form of digital money. As Christine Lagarde, President of the ECB has mentioned in the BIS Annual Report “… central banks have a duty to safeguard people's trust in our money. Central banks must complement their domestic efforts with close cooperation to guide the exploration of central bank digital currencies to identify reliable principles and encourage innovation.” according to RBI website.
The rationale for CBDCs in emerging economies is apparent - they are desired not only for the benefits they provide in payment systems, but they may also be required to protect the general public in a climate where private VCs are volatile.
RBI’s approach on CBDC
According to RBI website, “Generally, countries have implemented specific purpose CBDCs in the wholesale and retail segments. Going forward, after studying the impact of these models, launch of general purpose CBDCs shall be evaluated. RBI is currently working towards a phased implementation strategy and examining use cases which could be implemented with little or no disruption. Some key issues under examination are –
(i) the scope of CBDCs – whether they should be used in retail payments or also in wholesale payments;
(ii) the underlying technology – whether it should be a distributed ledger or a centralized ledger, for instance, and whether the choice of technology should vary according to use cases;
(iii) the validation mechanism – whether token based or account based,
(iv) distribution architecture – whether direct issuance by the RBI or through banks;
(v) degree of anonymity etc. However, conducting pilots in wholesale and retail segments may be a possibility in near future.”
Today, while presenting the Union Budget for 2022-23 in Parliament, she elaborated on how the introduction of Central Bank Digital Currency (CBDC) would provide a significant boost to the digital economy. “Digital currency will also lead to a more efficient and cheaper currency management system”, she said.
Here is a look at what is a CBDC and how it will work according the RBI.
What is a CBDC?
The full name of CBDC is Central Bank Digital Currency is a legal tender issued by the Reserve Bank of India (RBI). “CBDC is the same as currency issued by a central bank but takes a different form than paper (or polymer). It is sovereign currency in an electronic form and it would appear as liability (currency in circulation) on a central bank’s balance sheet. The underlying technology, form and use of a CBDC can be moulded for specific requirements. CBDCs should be exchangeable at par with cash,” according to RBI website.
What is a currency?
According to RBI website, “In modern economies, currency is a form of money that is issued exclusively by the sovereign (or a central bank as its representative). It is a liability of the issuing central bank (and sovereign) and an asset of the holding public. Currency is fiat, it is legal tender. Currency is usually issued in paper (or polymer) form, but the form of currency is not its defining characteristic.
What is the need for a CBDC?
While, there is a widespread interest in CBDCs, only a few countries have managed to progress beyond the pilot stage of developing their own CBDCs. According to RBI website, “A 2021 BIS survey of central banks found that 86% were actively researching the potential for CBDCs, 60% were experimenting with the technology and 14% were deploying pilot projects. Why this sudden interest? The adoption of CBDC has been justified for the following reasons:-
1. Central banks, faced with dwindling usage of paper currency, seek to popularize a more acceptable electronic form of currency (like Sweden);
2. Jurisdictions with significant physical cash usage seeking to make issuance more efficient (like Denmark, Germany, or Japan or even the US);
3. Central banks seek to meet the public’s need for digital currencies, manifested in the increasing use of private virtual currencies, and thereby avoid the more damaging consequences of such private currencies.”
CBDCs advantages over other digital payments system
“Payments using CBDCs are final and thus reduce settlement risk in the financial system. Imagine a UPI system where CBDC is transacted instead of bank balances, as if cash is handed over – the need for interbank settlement disappears. CBDCs would also potentially enable a more real-time and cost-effective globalization of payment systems. It is conceivable for an Indian importer to pay its American exporter on a real time basis in digital Dollars, without the need of an intermediary. This transaction would be final, as if cash dollars are handed over, and would not even require that the US Federal Reserve system is open for settlement. Time zone difference would no longer matter in currency settlements – there would be no ‘Herstatt’ risk," as per the RBI website.
Do we need CBDC in India?
India is leading the world in terms of digital payments innovations. Its payment systems are available 24X7, available to both retail and wholesale customers, they are largely real-time, the cost of transaction is perhaps the lowest in the world, users have an impressive menu of options for doing transactions and digital payments have grown at an impressive CAGR of 55% (over the last five years). It would be difficult to find another payment system like UPI that allows a transaction of one Rupee. With such an impressive progress of digitisation, is there a case for CBDCs?, RBI said.
“Given its dynamic impact on macroeconomic policy making, it is necessary to adopt basic models initially, and test comprehensively so that they have minimal impact on monetary policy and the banking system. India’s progress in payment systems will provide a useful backbone to make a state-of-theart CBDC available to its citizens and financial institutions", according to the Report of Trend and Progress of Banking in India 2020-21.
Small value transactions
There is a unique scenario in which the country's adoption of digital payments is accompanied with a continued interest in cash usage, particularly for small-value transactions. “To the extent the preference for cash represents a discomfort for digital modes of payment, CBDC is unlikely to replace such cash usage. But preference for cash for its anonymity, for instance, can be redirected to acceptance of CBDC, as long as anonymity is assured.” as per RBI website.
Cost of printing
Another advantage of CBDCs is India's high currency-to-GDP ratio. The cost of printing, transporting, storing, and distributing currency can be decreased to the extent that substantial amounts of cash can be substituted by CBDCs.
Advent of private virtual currencies (VCs)
“The advent of private virtual currencies (VCs) may well be another reason why CBDCs might become necessary. It is not clear what specific need is met by these private VCs that official money cannot meet as efficiently, but that may in itself not come in the way of their adoption. If these VCs gain recognition, national currencies with limited convertibility are likely to come under threat. To be sure, freely convertible currencies like the US Dollar may not be affected as most of these VCs are denominated in US Dollar. In fact, these VCs might encourage the use of US Dollar, as has been argued by Randal Quarles3. Developing our own CBDC could provide the public with uses that any private VC can provide and to that extent might retain public preference for the Rupee. It could also protect the public from the abnormal level of volatility some of these VCs experience. Indeed, this could be the key factor nudging central banks from considering CBDCs as a secure and stable form of digital money. As Christine Lagarde, President of the ECB has mentioned in the BIS Annual Report “… central banks have a duty to safeguard people's trust in our money. Central banks must complement their domestic efforts with close cooperation to guide the exploration of central bank digital currencies to identify reliable principles and encourage innovation.” according to RBI website.
The rationale for CBDCs in emerging economies is apparent - they are desired not only for the benefits they provide in payment systems, but they may also be required to protect the general public in a climate where private VCs are volatile.
RBI’s approach on CBDC
According to RBI website, “Generally, countries have implemented specific purpose CBDCs in the wholesale and retail segments. Going forward, after studying the impact of these models, launch of general purpose CBDCs shall be evaluated. RBI is currently working towards a phased implementation strategy and examining use cases which could be implemented with little or no disruption. Some key issues under examination are –
(i) the scope of CBDCs – whether they should be used in retail payments or also in wholesale payments;
(ii) the underlying technology – whether it should be a distributed ledger or a centralized ledger, for instance, and whether the choice of technology should vary according to use cases;
(iii) the validation mechanism – whether token based or account based,
(iv) distribution architecture – whether direct issuance by the RBI or through banks;
(v) degree of anonymity etc. However, conducting pilots in wholesale and retail segments may be a possibility in near future.”
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