What RBI needs to keep in mind for a new digital currency

• In Union budget presented few weeks ago, FM proposed to introduce digital currency in coming financial year.

Associated concerns with digital currency

• Slow and inefficient: compared to centralised ledger systems.
• Time to validate and settle transactions is high
• Number of transactions that can be handled is low.
• Account or token-based: Account-based framework, like bank deposits, links ownership with identity.
• Token-based framework, like cash, provides for greater anonymity.
• While former could increase risks for banks, latter raises concerns such as money laundering.

What will determine supply of CBDCs

• If the central bank decides to issue CBDCs above physical currency that it prints and injects every year into economy, it will lead to a significant expansion of its balance sheet.
• RBI can limit supply of digital currency by substituting it for some part of physical currency.
• It may result in capping digital currency in circulation, and amount that can be held by individuals and companies.
• It will limit its usage, at least in the initial years.
• It will also reduce risk of deposits shifting away from commercial banks,
• During financial distress, depositors will move from bank deposits to CBDCs and aggravate crisis.

Will digital currency be interest-bearing?

• It will effect financial system and monetary policy.
• Banks will face threat of deposits shifting to CBDC, and losing out on their source of funding.
• They may respond by raising funds at higher costs, which will impact their margin or lending rates, thus affecting credit demand.
• Considering these RBI may place a permanent “window” for banks, to help offset any asset-liability mismatches that may arise.
• There is usage of cash to contend with.
• Indian economy is still characterised by widespread use of cash.
• Limiting physical currency in circulation may have adverse effect economy that are predominantly dependent on cash as a medium of exchange.
• The large informal economy, especially the agricultural sector

Conclusion

• Central bank should explore to what extent benefits of issuing CBDCs will materialise in India.
• There is reason to be sceptical as India already has a robust payments infrastructure in place.
• The domestic payments ecosystem is characterised by low transaction costs and quick turnaround time.
• And, unlike China, there is healthy market competition. So to what extent the introduction of a CBDC will aid in further accelerating financial inclusion, facilitating low-cost transactions for low-income households, is debatable.