Date: 18/10/2022

Relevance: GS-3: Developing New Technology; Indian Economy.

Key Phrases: Central Bank Digital Currency, Primary functions of money, digital banking, Issuance mode, Form of issuance, Interest payment, Anonymity, legal tender, fiat currency, financial inclusion, reduced operating cost.

Why in News?

• The RBI’s concept paper on CBDC (Central Bank Digital Currency) sets in motion the process for its introduction. There are different stages of evolution in digitalization and CBDC is the last frontier.

Primary functions of money:

• Irrespective of the form of money, in any economy, money performs three primary functions – a medium of exchange, a unit of account, and a store of value.
• Money as a medium of exchange may be used for any transactions wherein goods or services are purchased or sold.
• Money as a unit of account can be used to value goods or services and express it in monetary terms.
• Money can also be stored or conserved for future purposes.

What is Central Bank Digital Currency (CBDC)?

• According to the RBI, “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.”
• The digital fiat currency or CBDC can be transacted using wallets backed by blockchain.
• Though the concept of CBDCs was directly inspired by Bitcoin, it is different from decentralized virtual currencies and crypto assets, which are not issued by the state and lack the ‘legal tender’ status.
• CBDC has been defended on grounds of its being more efficient, and innovative, being able to foster financial inclusion, and reducing operating costs.
• For it to work smoothly, however, it needs to be accessible to all, especially the poor who may not have access to any electronic device. This can be a challenge when it comes to serving the purpose of financial inclusion.

Cost reduction:

• Operating cost may not matter for the RBI but given that physical currency moves across banks through vaults and ATMs, CBDC will help in cutting down costs.
• The total expenditure incurred on security printing from April 1, 2021, to March 31, 2022, was ₹4,984.80 crores as against ₹4,012.10 crores in the previous year (July 1, 2020, to March 31, 2021).
• Complementing the higher cash requirement of the country, CBDC will lead to a lowering of cost as it would obviate the need for many processes associated with the distribution of physical currency across the country.
• Given the geographical spread and pockets, where making physical cash available is a challenge, CBDC is expected to facilitate seamless transactions.

Concerns raised:

• Technology:
  • The major challenge here is to make it accessible to those who have limited access to electricity or the internet or are not comfortable with technology, especially smartphones.
  • A large elderly educated population is not comfortable with digital banking.
• Accessibility:
  • The wholesale and retail transactions both would be included through CBDC; hence the design of the CBDC will be one that can be accessed by not just corporates and banks but also the man on the street. Then, it shall be universal.
• Issuance mode:
  • The paper debates the issuance and maintenance by the central bank or commercial banks, as both options exist.
  • It opts for the latter which sounds fair as it would mimic how currency is dealt with.
  • Just as individuals go to a bank to withdraw money and not to the RBI, the CBDC would also be managed by the banks through the accounts of the deposit holders.
• Form of issuance:
  • Here the paper talks of it being token-based like a currency note or account-based which is akin to bank deposits.
  • The view taken is that the former is appropriate as the holder is the owner and hence there would be no account maintained as such. To this extent, it would be like physical currency.
• Interest payment:
  • The option is to pay an interest rate on the CBDC which will be an incentive to the holder.
  • Doing so will put it in conflict with banks which can visualize deposits being converted to CBDC rather than lying with the bank.
  • Considering that physical cash does not carry any interest, it would be more logical to offer non-interest-bearing CBDCs.
  • If adopted, theoretically, all e-wallets become redundant and hence this industry should be watchful.
  • Given a choice to lodge balances in the CBDC or a private e-wallet, the former sounds like a safer bet.
• Anonymity:
  • For CBDC to play the role of a medium of exchange, it needs to incorporate all the features that physical currency represents including anonymity, universality, and finality.
  • Ensuring anonymity for a digital currency particularly represents a challenge, as all digital transactions would leave some trail.
  • Yet if CBDC is to be akin to cash, it is important to note that cash is favoured for its anonymity.
  • While the government has imposed restrictions on the amount of cash that can be used for commercial transactions, the currency still has its charm.
  • It can be used for social functions, property transactions, jewellery purchases, etc., where one can remain anonymous.
  • While the concept paper says that small value transactions will remain anonymous (but every SIM card is identified with an individual), the higher ones will be under the IT radar. It needs further clarification.

Conclusion:

• CBDC, the central bank digital currency, holds a lot of promises by way of ensuring transparency, and low cost of operation among other benefits, and the potential to expand the existing payment systems to address the needs of a wider category of users.
• Setting this up will require careful calibration and a nuanced approach to implementation.
• As is said, every idea will have to wait for its time. Perhaps the time for CBDCs is nigh.

Source: The Hindu BL

Mains Question:

Q. What is Central Bank Digital Currency (CBDC)? What are the merits of the issuance of CBDC as well as the challenges associated with it?