CBDC or Central Bank Digital Currencies is a concept which is seriously being worked upon by the RBI in order to introduce the nation to the world of regulated digital currency. A CBDC to simply put is the legal tender issued by a central bank in a digital form.

It is an undebatable fact that even banks wish to digitise currencies rather than having them in paper form. Great examples are countries like Sweden which have progressed a lot in digitising their currencies. Fo Also , goverment around the world are clear that they do not wish to expose the public to the dangers that the private cypto currencies impose and fullfil the needs of the people of the digital currencies by launching a cetralised currency that is a legal tender. For this purpose, the concept of CBDC is used by any country to launch their own digital currency. Countries with significant physical cash usage ( like Denmark, Germany, or Japan or even the US) will also be looking to move to CBDC to make issuance more efficient.

In addition, CBDCs have some clear advantages over other digital payments systems – payments using CBDCs are final and thus reduce settlement risk in the financial system. Imagine a UPI system where CBDC is transacted instead of bank balances, as if cash is handed over – the need for interbank settlement disappears. CBDCs would also potentially enable a more real-time and cost-effective globalization of payment systems. It is conceivable for an Indian importer to pay its American exporter on a real time basis in digital Dollars, without the need of an intermediary. This transaction would be final, as if cash dollars are handed over, and would not even require that the US Federal Reserve system is open for settlement. Time zone difference would no longer matter in currency settlements – there would be no ‘Herstatt’ risk.

Do we need CBDC in India?

India has a high currency to GDP ratio holds out another benefit of CBDCs.The total currency in circulation or the cash in the system was at ₹28.6 trillion as of March end, an increase of 16.8% from the year earlier. To the extent large cash usage can be replaced by CBDCs, the cost of printing, transporting, storing and distributing currency can be reduced.

This advantage of issuing a CBDC might be enough to justify India issuing a CBDC, but to realize benefits of global settlements, it is important that both the countries in a currency transaction have CBDCs in place. Let us, however, look at it from India’s own point of view.
India is leading the world in terms of digital payments innovations. Its payment systems are available 24X7 real-time, available to both retail and wholesale customers and the cost of transaction is perhaps the lowest in the world, users have an impressive menu of options for doing transactions and digital payments have grown at an impressive CAGR of 55% (over the last five years). It would be difficult to find another payment system like UPI that allows a transaction of one Rupee. With such an impressive progress of digitisation, is there a case for CBDCs?

A pilot survey conducted by the Reserve Bank on retail payment habits of individuals in six cities between December 2018 and January 2019, results of which were published in April, 2021 RBI Bulletin (please see charts below) indicates that cash remains the preferred mode of payment and for receiving money for regular expenses. For small value transactions (with amount up to ₹500) cash is used predominantly.

This means that the advent of private virtual currencies (VCs) can be the biggest reason why CBDCs might become necessary for the economy. It is not clear what specific need is met by these private VCs that official money cannot meet as efficiently. If these VCs gain recognition, national currencies with limited convertibility are likely to come under threat. To be sure, freely convertible currencies like the US Dollar may not be affected as most of these VCs are denominated in US Dollar. In fact, these VCs might encourage the use of US Dollar, as has been argued by Randal Quarles³. Developing our own CBDC could provide the public with uses that any private VC can provide and to that extent might retain public preference for the Rupee. It could also protect the public from the abnormal level of volatility some of these VCs experience. Indeed, this could be the key factor nudging central banks from considering CBDCs as a secure and stable form of digital money. As Christine Lagarde, President of the ECB has mentioned in the BIS Annual Report “… central banks have a duty to safeguard people’s trust in our money. Central banks must complement their domestic efforts with close cooperation to guide the exploration of central bank digital currencies to identify reliable principles and encourage innovation.”