Expectations are sky-high that the “digital rupee” — a central bank digital (crypto) currency (CBDC) announced by finance minister Nirmala Sitharaman in her Budget speech this year — will ensure a quantum jump to the digital economy, enhance GDP growth and boost financial inclusion.
Nigeria and eight Caribbean countries have launched CBDCs. Fourteen, including China, Sweden, Singapore, South Korea, Malaysia, Thailand, the UAE, Saudi Arabia, and South Africa, run pilot projects as per the Atlantic Council cyber tracker. A few include limited cross border settlements.
The motivations vary, from providing public competition to entrenched private cryptocurrencies (Sweden) to the pervasive monitoring of transactions and building the foundations of global financial dominance (China), or generally joining a growing global ecosystem. India possibly, fancies the enhanced monitoring and ecosystem advantages. So, what would the digital rupee look like and who could benefit or lose?
But first, a review of the technical fundamentals. Cryptocurrencies are managed using the so-called “blockchain” technology. This software replicates the humble accountant’s ledger in which all transactions are entered, verified, balances reconciled and stored safely. For currencies, the ledger entries could be the opening and closing balance of coins available with each participant (“nodes”) and transfers within and between nodes.
A “chain” consists of “blocks” — interlinked series of transactions, all emerging from the previous block to which it is linked. The size of the blocks, in computational capacity, can be programmed to suit needs. Transactions, within and between blocks, take place across multiple “nodes” — functionally akin to transaction termination points. Physically these are online computers linked into the network, owned by coin miners and storage and payment wallets.
The key difference in blockchain accounting is that the transactions are verified and authenticated, by all the linked nodes, before they are registered. This enables ledgers, maintained separately by each node — hence the name distributed ledgers — to match perfectly. In standard accounting, periodic audits authenticate the accounts after payment finalisation. In blockchains, pre-audit at the time of the transaction is also the final audit. A single node can veto a transaction, resulting in freezing the related block and make it an inoperable, “orphaned block”. Real-time authentication makes fraudulent transactions difficult and possibly, commercially unrewarding.
This massive accounting exercise requires sufficient computational capacity at each node to continuously verify and authenticate millions of transactions. India recorded 26 billion online transactions in 2021 (Forbes), which were just 20 per cent of all transactions. The high volume highlights the energy intensity of online instant-accounting, on top of the energy-intensive mining of crypto-coins — a source of worry for environmentalists, unless renewable energy is used.
The digital rupee will also use the blockchain, but not the decentralised ledger system used by commercial cryptocurrencies, which need a decentralised ledger to provide assurance about authenticity and security. A CBDC is a digital banknote, issued and guaranteed by the Reserve Bank of India (RBI), with the added advantage of being transactable online, on receipt, without intermediation by a bank or a payment wallet, if users get to open accounts directly with the RBI or its designated agents.
Divesting the RBI of its monopoly in printing money and leaving monetary policy to be determined just by setting the base interest rate with emergency use of reserves to add or drain liquidity would be highly disruptive. The RBI profits from “seigniorage” — the difference between the cost of printing, storing and transporting cash and its face value, particularly high-value notes — which feeds into the revenue receipts of the government. Also, the decentralised ledgers for money creation and anonymous transfer facilities — the leitmotif of a cryptocurrency — could subvert the existing capital controls on international transfers of money, undo the digitalisation push to tame rampant tax evasion and facilitate the online financing of criminal activities.
A 2021 RBI survey, across six cities, however, showed a preference for cash — 87 per cent for transactions below Rs 100, reducing to 30 per cent above Rs 5,000. Cash still rules in the more populous rural areas. A smartphone costs one month’s earnings for the bottom three deciles (80 million households). Women face heightened digital inequality. Also, the patchy telecom network does not build confidence in a zero-cash reserves strategy.
The RBI will likely opt for a dual strategy -- providing the digital rupee as an option or compulsory only for high-value and wholesale transactions. This will mask the actual efficiency gains because wholesale and high-value retail transactions (above Rs 1 lakh for self and above Rs 50,000 for third party payees) are already compulsorily online. The real efficiency gains will come from converting offline retail transactions to digital mode. But equity considerations abjure this for the time being.
This dual strategy — low cost, direct digital banking with the RBI for the big boys while trapping small depositors in high-cost bank intermediation — could have perverse consequences by diluting the feel-good factor, that the facilitation of 420 million Jan Dhan bank accounts and 309 million RuPay cards evoked around enhanced financial inclusion.
The CBDC, like cash, will be the direct liability of the RBI and hence safer than deposits in banks where bank failures impact depositors, even though the RBI provides a backstop guarantee up to Rs 5 lakhs per depositor. If the RBI allows large depositors to open accounts directly with it or its selected agents, funds would be diverted away from banks, particularly if CBDC accounts are interest bearing.
Lower access to cheap deposit funds would squeeze bank margins, forcing them to charge more for their customer services and reduce their capacity to lend. This could have a positive, unintended consequence, by opening space for efficient, small, private banks to increase their business in small credits at reasonable charges — an option that is now marginalised by the ability of public sector banks to mask their higher costs in small credits by cross subsidising from the high margins from large credit requirements.
With indifferent efficiency gains, and possibly the heightened perceived inequality between the online haves and the offline have-nots, why is a digital rupee the preferred option? The answer lies in the medium term by when significant efficiency gains will come in international payments, which remain exceedingly costly due to multiple and mismatched standards and regulations. The Bank of International Settlements is steering global standards towards interoperable CBDCs. For India, the fastest growing large economy, it makes sense to play from the bench rather than watch from the stands.
