What is digital rupee? And How it will work?

• Union finance minister has announced the RBI will soon issue a central bank-backed digital currency (CBDC).
• CBDC is a digital or virtual currency but is not comparable to the private virtual currencies that have mushroomed over the last decade.

What is CBDC?

• CBDC is the legal tender issued by a central bank in a digital form.
• It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different.

What is the difference between CBDC and Cryptocurrency?

• CBDC is a digital or virtual currency but is not comparable to the private virtual currencies that have mushroomed over the last decade.
• As per RBI, private virtual currencies are at substantial odds with the historical concept of money because they are not commodities or have no intrinsic value.
• While a CBDC is centralised, cryptocurrencies are decentralised and do not represent any person’s debt or liabilities and have no issuer.

Does CBDC Affect Banks?

• Yes, they could cause dislocations depending on the design of the CBDC.
• It could reduce transaction demand for bank deposits, but they reduce settlement risks.
• Being risk-free, CBDC can lead to a shift away from bank deposits, cutting government guarantees on deposits.
• If banks lose deposits, their ability to create credit will be constrained because central banks cannot provide credit to the private sector.

Do we need CBDC in India?

• There is thus a unique scenario of the increasing proliferation of digital payments coupled with a sustained interest in cash usage, especially for small-value transactions.
• CBDC is unlikely to replace cash usage. The high currency-to-GDP ratio, if switched to CBDC, would cut the cost of printing, transporting, storing and distributing currency

Why do we need CBDC?

• With the dwindling usage of paper currency, there is a need to popularise electronic forms of currency.
• This becomes efficient in high physical cash usage economies like India and Germany.
• Also, this will be a substitute for private digital currencies.

How will CBDC change Monetary Policy?

• Historically, monetarists targeted the supply of broad money through bond purchases, sale and purchase of currencies and tinkering with the reserve ratios of banks.
• But the demand for money became unstable when finance got globalised at the beginning of the ‘90s.
• This forced central banks to target interest rates.
• Now with CBDCs, they could assess demand for money and get a better handle on their policies.