Challenges persist in terms of cybersecurity, scalability, speed, and privacy aspects of the digital rupee

The much-awaited Central Bank Digital Currency (CBDC) pilot project by the Reserve Bank of India (RBI) was launched amidst much fanfare. To give the readers a brief understanding of how the e-rupee works – in essence, e-rupee is cash, except in a digital form. If users want to make payments for the purchase of goods and services, then tokens issued by the RBI will be transferred through the RBI’s centralised blockchain network to the merchant or a peer. Commercial banks will be involved in distributing the e-rupee tokens to the public. The key difference between current digital money and CBDC is that the latter is a direct liability of the Reserve Bank of India, and not of a commercial bank.

The decision of the RBI to launch CBDC took industry watchers worldwide by surprise as it has been a crucial decision that most major economies have been delaying. The US Federal Reserve has yet to decide on CBDCs, mentioning that it is still debating the potential benefits and hazards from various aspects, including thorough technology study and experimentation.

Similarly, the European Central bank is still exploring how to design and distribute the digital euro and assessing the potential market effects. On the other hand, Japan might put off a call until 2026. India’s hurried deadline is at least partially a response to cryptocurrencies and a race to beat China, which by early November had about 140 million people registered for its e-CNY. However, there is yet to be a nationwide roll-out timetable for China; Alipay and WeChat Pay continue to dominate digital payments. So, is India’s hurry to roll out CBDC worth it? Do the potential benefits overcome the trade-offs? How contextually justified are the RBI’s motives with regard to CBDC?

Financial Inclusion

For CBDC projects, financial inclusion is a common policy objective. Access to adequate and cheap financial services is a requirement for financial inclusion, which is linked to a reduction in global poverty. Access to digital technologies is one of the several obstacles to greater financial inclusion. By making digital payments more accessible, CBDCs act as a doorway for broader access to financial services and hence, contribute towards greater financial inclusion.

In the Bahamas and The Eastern Caribbean Currency union countries, being island nations, chunks of the population were financially excluded as commercial banks needed to find opening up their banks commercially feasible in the islands. Hence, in these countries, the adoption of CBDCs alleviates the geographical barriers to access to banking services, as CBDCs can be operated digitally over smartphones.

The Global Findex report 2021 reports that about 78% of the Indian adult population have bank accounts, as opposed to 35% in the year 2011. In addition, adopting the Unified Payments Interface (UPI) has been a notable success so far, transforming India’s payment system. A year after UPI’s introduction, its share in total payments stood at just 6%, which increased sharply to 63% by FY21.

Fortifying Technology

In India, well-established, well-adopted, and stress-tested robust payments systems like the UPI are doing incredibly well at onboarding Indians onto the digital payments platform. So, in our opinion, the introduction of CBDC to foster financial inclusion hurriedly is not the need of the hour; instead, the central bank should invest more time and resources in fortifying the technology of digital tokens and developing contingency plans to tackle any failure of the digital-rupee so that financial stability in the country is not impeded.

In Ecuador’s case, the use of digital currency was unsuccessful. It was one of the first nations to introduce a digital currency. However, it was eventually compelled to abandon it after three years because more than 70% of the population still needed to open up a CBDC account. The people of Ecuador never used digital currency because they needed more confidence in the nation’s financial system.

In the case of India, can the RBI afford to take the risk of failure, as about one-third of Indian adult bank account activity is inactive as per the Global Findex survey 2021? The most commonly cited reasons are lack of trust in the financial system, lack of bank use and distance to a financial institution. The report highlights significant gender differences in ownership and usage of financial services in our country.

Around 32% of Indian women have inactive bank accounts as opposed to 23% males, and in terms of digital transactions, females are lagging behind males by a huge margin. Forty-one per cent of the male population made/received digital payments whereas females only 28%. Also, access to credit/debit cards illustrates key gender differences with male and female access at 35% and 20% respectively. The government should focus on bridging the gender differences in ownership and usage of financial services in our country to empower women and lead the path towards universal financial inclusion.

Implications

It is paramount that the government assesses the implications of CBDC on monetary policy and macroeconomy stability. First, the CBDC is expected to increase allocative efficiency in the commercial banking system. Greater efficiency, however, might come at the cost of a concentrated banking sector, where small banks go bankrupt due to the lack of access to large funding markets leading to a spike in mergers and acquisitions.

Second, the digital currency is expected to promote financial stability by providing timely signals to the banking sector on the likelihood of bank runs. However, the speed and efficacy of the bank’s response to such signals depend on the existing quality and level of financial development in the country.

Finally, CBDC can be designed to be a direct tool of monetary policy, by impacting the intertemporal financial decisions of firms and households. However, it will massively increase the liabilities of central banks. When issued for retail purposes, it will appear as a liability item in the balance sheet of central banks. The rising cost of monetary policy interventions due to CBDC will influence and limit the government’s ability to pursue independent fiscal policy interventions.

These factors suggest that CBDCs are more effective in countries with more mature financial systems and infrastructure. In the context of emerging economies like India, the government must first strengthen the demand for money among the consumer base, through financial inclusion, job creation and growth in wages or per capita incomes, before implementing it.

We recognise that the adoption of CBDC can generate potential benefits, as mentioned earlier. However, we recommend that the RBI should not hastily introduce it without doing much groundwork on the challenges that could persist in terms of cybersecurity, scalability, speed and privacy aspects of the e-rupee and its ripple effect on monetary policy and economic performance of the country.