A few years ago, at an All-India Conference, I had spoken about the impending death of cash. I, of course, conceived of all transactions, including with vegetable vendors, happening through electronic interface via phones, laptops and so on, which are now sort of normal. Today, thanks to the pandemic, with everything turning electronic, it is not very surprising that the Rupee, too, has intentions of going electronic! Yes, India's central bank, the Reserve Bank of India, is considering the introduction of central bank digital currency (CBDC).
Till now, no country has officially launched a CBDC except for putting out pilot projects aimed at determining viability and usability. The Bank of England and the People's Bank of China are some examples. Russia toyed with a crypto-ruble in 2017. Right now, we don't know how it will pan out, but let's take a look.
So what is CBDC and what are its pluses and minuses, and how does it score on balance?
My oversimplified observation is that the CBDC will be a digital representation of the Rupee. Each unit will be a secure digital instrument and will be equal to a value of paper money. Each CBDC will have a unique serial number to track its movement and prevent imitation. Ideally, when digital currency is issued, it should be backed by reserves such as gold or foreign currency. It can then take all the characteristics of money: a medium of exchange, a standard of the store, and a measure of value.
In all likelihood, the CBDC would be based on a database run by the central bank, the government or some approved entity. They would then keep a record of the amount of money held by every entity, such as people and corporations.
Why we must have it
Here is a list of potential advantages:
· Payments can be made directly between payer-payee without going through banks and clearing houses.
· Every citizen now gets a low-cost, basic banking solution, and we thus move to financial inclusion swiftly and more fully.
· The government can track and arrest illicit dealers, including corruption, which has for long been a national pastime.
· A digital record provides proof that money changed hands, and that simplifies auditing.
· Free bank accounts at the central bank will encourage competition amongst banks to offer better deposit rates.
· The government can fashion directed spending. In the trial of digital Yuan, the CBDC had an expiry date, which meant people had to spend their money instead of saving.
· CBDC is cheaper for everyone as it does not have production, storage, transportation, and disposal costs.
Why we must be careful
Everything is not hunky-dory with CBDC. It can open a can of worms.
· CBDCs are likely to be accepted only in the issuing country.
· The RBI will end up competing with the banks, which they are supposed to regulate. It's like the umpire playing the game with the cricketers. People will shift their money from banks to the more safe CBDC, and, in some cases, it could create a run on the bank. Of course, this can be obviated if the central bank keeps a limit on the digital holding.
· The central banks need to have the ability, scale, and resources to handle such a huge redirection of public deposits. Demonetisation showed that we are just not there.
· If CBDC is centralised, as it is expected to be, the controllers can add or remove money from anyone's account just like that. That's because it's not decentralised, and one person has control. In crypto-currencies, with a distributed ledger, you can't alter unless a group of users controlling more than 50 per cent of mining power come together.
· For no reason, it empowers the central government to say who gets money and who doesn't. This would embolden central government-sponsored discrimination. It could also be an intrusion of privacy.
· The central bank must increase its reserves to show liquidity. If they show reserves, then they can't use these reserves against big infrastructure and technical projects.
On balance
Yes, CBDC brings the convenience and security of digital form and the regulated, reserved-backed money circulation of the traditional banking system. But India really doesn't need faster payments at the moment. We already have quite a world-class payment system. We can hardly trust our central government with oversight, and this is on either side of the political divide. We did not need CBDC to improve financial inclusiveness. In 2014, we brought millions into the formal banking system with ease.
Perhaps, just perhaps, to keep up with time, one can look at bringing a small per cent of money as digital currency without removing paper in toto.
(The author is a CA, an author, teacher, and public speaker.)