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Digital Rupee

2022 OCT 20

Mains   > Economic Development   >   Indian Economy and issues   >   Digital technology

IN NEWS:

  • Recently, the Reserve Bank of India (RBI) said that it will soon commence limited pilot launches of e-rupee (e?), or Central Bank Digital Currency (CBDC) or digital rupee, for specific use cases.
  • The central bank also released a concept note on Central Bank Digital Currency (CBDC) that aims to create awareness about such currencies in general and the planned features of the Digital Rupee in particular.

MORE ON NEWS:

  • RBI said that the development of CBDC could provide the public a risk-free virtual currency that will give them legitimate benefits without the risks of dealing in private virtual currencies.
  • The approach for issuance of CBDC will be governed by two basic considerations — to create a digital rupee that is as close as possible to a paper currency and to manage the process of introducing digital rupee in a seamless manner.
  • The central bank also feels that it is desirable for CBDCs to have offline capabilities to make it a more attractive and accessible medium of payment for a wide category of users.

WHAT IS CBDC?

  • RBI broadly defines CBDC as the legal tender issued by a central bank in a digital form.
  • CBDC would be similar to the sovereign paper currency, though digital.
  • According to the concept note released by RBI, CBDC is akin to sovereign paper currency but takes a different form, exchangeable at par with the existing currency and shall be accepted as a medium of payment, legal tender and a safe store of value.
  • Also, CBDCs would appear as liability on a central bank’s balance sheet.

TYPES OF DIGITAL RUPEE (e?)

  • The RBI’s concept note says that, based on the usage and the functions performed by the digital rupee and considering the different levels of accessibility, CBDC can be demarcated into two broad categories:
    • General purpose (retail) (CBDC-R):
      • CBDC-R is meant for retail consumption and can be availed by all including the private sector, non-financial consumers and businesses.
    • Wholesale (CBDC-W)
      • CBDC-W is meant for interbank transfers and wholesale transactions by financial institutions.

MODEL FOR ISSUANCE:

  • As per the concept note, there are two models for issuance and management of CBDCs viz.
    • Direct model (Single Tier model)
      • A Direct model would be the one where the central bank is responsible for managing all aspects of the CBDC system viz. issuance, account-keeping and transaction verification.
    • Indirect model (Two-Tier model)
      •  In an Indirect model, central bank and other intermediaries (banks and any other service providers), each play their respective role.
      • In this model central bank issues CBDC to consumers indirectly through intermediaries and any claim by consumers is managed by the intermediary as the central bank only handles wholesale payments to intermediaries.

FORMS OF CBDC:

  • CBDC can be structured as ‘token-based’ or ‘account-based’.
    • A token-based CBDC is a bearer instrument like banknotes, meaning whosoever holds the tokens at a given point in time would be presumed to own them.
    • In contrast, an account-based system would require maintenance of record of balances and transactions of all holders of the CBDC and indicate the ownership of the monetary balances.

DIGITAL CURRENCY Vs CRYPTOCURRENCY:

Cryptocurrency is a decentralized digital currency transferred directly between peers and the transactions are confirmed in a public ledger – which is accessible to all the users. Technically, they are pieces of code created by ‘mining’ that are managed through a digital ledger called as blockchain. There are several differences between digital currency and cryptocurrency:

  • Centralisation:
    • In case of digital currency, control lies with the Central bank, like the Reserve Bank in India. But cryptocurrency follows a decentralized procedure and its value is independent of central banking control.
  • Encryption:
    • Cryptocurrencies rely on a blockchain and are stored in ‘wallets’ that offer a much higher degree of cyber security. However, Digital currencies are essentially e-cash that does not need necessarily need blockchain technology for storage and processing.
  • Transparency:
    • Every detail regarding cryptocurrency transactions is in the public domain thanks to the presence of a decentralised ledger that records all the blockchain details. With digital currency, only the banking authorities along with the sender and receiver are involved in the transaction involved.
  • Stability:
    • Due to their sovereign backing and wider acceptance, digital currency is stable and relatively easy to manage. Cryptocurrency lacks the backing, which hampers its stability and creates large price volatility.
  • Legality:
    • For now, countries around the world are firm in backing their own fiat currencies. As for cryptocurrencies, some countries like China and Bangladesh, have banned its use while some like El Salvador permit its use as legal tender.

RATIONALE BEHIND DIGITAL CURRENCY:

  • Advantages over paper currency:
    • Demonetisation and UPI based payment systems have reduced the usage of paper currency. Also, the cost of issuing digital currencies is far lower than the cost of printing and distributing physical cash. Hence, a CBDC can become a more acceptable electronic form of currency.
  • Financial inclusion:
    • RBI’s annual Financial Inclusion Index for the financial year ended March 2021 was 53.9, indicating that India has a long way to go in ensuring universal financial inclusion.
    • CBDCs can establish a more direct connection between consumers and central banks, thus eliminating the need of expensive infrastructure to bring financial access to the unbanked population.
  • Reduce transaction time:
    • CBDC will eliminate the need for interbank settlement. Also, payments using CBDCs are final and thus reduce settlement risk in the financial system.
  • Reduce transaction cost:
    • Cross-border payments suffer from transaction delays, multiple fees and several intermediaries resulting in high transaction cost. This can be lowered through CBDC, as it can be transferred peer-to-peer without going through the complex settlement system.
  • Meet public demand for digital currencies:
    • There is an increasing demand for digital currencies, like Bitcoin and Ethereum, in India. Central bank digital currencies are promised as reliable, sovereign-backed alternatives to private currencies which are volatile and unregulated.
  • Eliminate leakages:
    • Unlike physical cash, which is hard to trace, a digital currency can be more easily tracked and controlled by the Central bank. This has the potential to help reduce black money and terror financing. Also, programmable/targeted payments can be made through CBDC, which can reduce leakages in subsidies.
  • Becoming common across the world:
    • Several countries, including the United States and China, have been working towards issuing their own CBDC in recent years. India need its own CBDC or else would it stands to lose in the digital sphere of geopolitics.

CONCERNS:

  • Cyber-attacks and payment-related frauds:
    • CBDC ecosystems is at similar risk for cyber-attacks as the current payment systems are exposed to.
    • Also, RBI recognises there is an increased probability of payment-related frauds in countries with lower financial literacy levels.
    • Ensuring financial literacy and cyber-security thus becomes very important.
  • Privacy concerns:
    • CBDCs would require some amount of intrusion by authorities to monitor for financial crimes. However, this stands in violation of an individual’s privacy.
  • Technical glitches:
    • Recently, a digital currency that is being used by seven Carribean nations experienced glitches that have kept it offline for more than a month. The occurrence of such glitches can affect the financial security of the country.
  • Fear of bank run:
    • Since CBDC can provide a risk-free alternative to bank deposits, people may begin withdrawing their bank deposits and convert it into digital cash. This disintermediation of banks can potentially affect their ability of credit creation.
  • Impact on monetary policy:
    • CBDCs may bring about a change in the behaviour of the holding public. The nature of change this would bring on the effectiveness of monetary policy cannot be gauged a priori given that no central bank has launched CBDC.
  • Digital divide:
    • Based on National Sample Survey data, only 38% of households in India are digitally literate (61 % in urban areas and 25% in rural areas). Also, India has a gender gap of 40.4 percent in internet usage, with only 15 percent of women accessing the internet versus 25 percent of men.
    • Introducing a system like CBDC into this population can result in many missing out on the benefits of CBDC or being exploited by middlemen.
  • Interoperability challenges:
    • The IMF has observed that fragmented international efforts to build CBDCs would likely result in interoperability challenges and cross-border security risks.

WAY FORWARD:

The move to introduce a CBDC is a progressive step for India. However, the central bank needs to make necessary preparations to allow all stakeholders to effectively utilise the digital currencies. This can include:

  • Strong cyber security: Efforts to prevent system penetration and theft of assets and information are needed.
  • Data protection regime: The data protection bill needs to be passed to ensure a balance between individual rights and tracking to CBDCs.
  • Efforts to enhance financial literacy.
  • Cap the amount of money that an individual can hold as CBDCs, in order to prevent the mass withdrawal of deposits from banks.
  • Develop plans to inject fresh money into banks, if needed, to ensure that the ability of banks to create loans is not affected once the currency is introduced

CONCLUSION:

  • CBDC, across the world, is in conceptual, development, or at pilot stages. Therefore, in the absence of precedence, extensive stakeholder consultation along with iterative technology design must take place to develop a solution that meets the requirements. While the intent of CBDC and the expected benefits are well understood, it is important to identify innovative methods and compelling use cases that will make CBDC as attractive as cash if not more.

PRACTICE QUESTION:

Q. Discuss the rationale behind the introduction of digital rupee? Also mention the challenges associated with its introduction?