Rupee to Digital Rupee? – Central Bank Digital Currency

Written by - Vibhav Bhat and Yash Prashant Bhave

PGDM Finance- TAPMI, Manipal

We all have seen movies based on the future with flying cars and all transactions taking place by a tap or retinal scan. Unlike today where transactions take place with physical cash or swipes. “Change is the only constant in life” quoted by Heraclitus, a Greek Philosopher, which is also applicable in the case of currencies. Although we might not have a flying car yet, in transaction systems we have moved from the barter system, to precious metals and now to paper-based and digital currencies. 30-40 years down the line surely there will be something new that we might add.

What is digital currency?

Digital currency is nothing but a currency that is available only in the digital or electronic form. It consists of Debit cards, Credit cards, Internet banking, various payment applications, and Cryptocurrency. In all these, Cryptocurrency has a major contribution. Some digital currencies can be converted into physical form like we can withdraw cash by using an ATM. Even China has rolled out its digital yuan backed by blockchain and temper proof ledger usage.

Fig: Top 10 global digital currencies

Source: Epixel MLM Software

Table: Digital currency market cap.

Source: Statista

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What is CBDC?

CBDC stands for Central Bank Digital Currency. It is same as fiat currency and has one to one exchange. It is just on digital medium. There are two types as we can see from the chart, wholesale and general/retail purpose. Wholesale is the corporates. In the last few years, there has been a lot of activity around both private and central bank-issued wholesale digital currencies. Real disruption kicks in as households and businesses will use them in daily transactions.

Figure: Banks operations and digital currency exposure

Source: C Boar and A Wehrli BIS papers, Bank of International settlement report

A total of 65 central banks responded and out of that, we can see that the majority focuses on both segments. In the case of experiment and development bifurcation majority of them are in the experiment phase.

So, why is the central bank planning for digital currency? The answer for that varies with the central banks and with the domain in which they are offering. However, the Central bank has maintained its position that it will complement cash and not replace it. It will provide safe payment options. This will not only increase efficiency, reduce transaction costs but will also promote financial inclusion.

Fig: Backend of implementation

Source: R Auer and R Bohme, BIS Quarterly Review, Bank of International settlement report

Fig: Bank responses on CBDC

Source: C Boar and A Wehrli BIS papers, Bank of International settlement report

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Why is it being rolled out by the Central Bank?

There is a rising trend of people moving towards digital currencies. To satisfy this demand the central bank is rolling out CBDC. They are promised to be more reliable than private digital currencies like bitcoin. However, another point to note is the demand for private currencies is majorly backed by the limitation of the currency. Mere shifting of rupee to digital rupee does not guarantee a shift in demand from private digital currency demand to the digital rupee.

Also, digital money transactions can be easily monitored and traced. Unlike physical cash, this will provide additional control for regulators to monitor the transactions and activities in the economy. However, this raises a concern regarding privacy which is a major issue for successful implementation. At the same time the system can ensure safer procedures of transactions.

Another reason is RBI wants to reduce the dependency on paper-based currency currently in use. According to the central bank the cost of issuing digital currency is much lower than printing and circulation of cash. Currently the system takes a strain in circulation of physical cash and restoration/ exchange of old and non-usable currency bills. The digital currency can reduce this strain once it is widely adopted.

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Road Ahead

The future holds the key to this answer. But we can speculate how it can change the normal way of transactions. RBI has assured that launching of CDBC will be done in a phased manner to improve adoption and reduce chaos in the existing economy. The below image marks out the important aspects to look at during the implementation phase of the currency.

Fig: Aspects of consideration during phased implementation of CBDC

One important point to note here is the current banking infrastructure might be adversely affected due to implementation of CBDC. IT can lead to mass withdrawal leading to liquidity risk situations. It can also hamper the lending and credit creation abilities of the bank in the economy. Rescuing these institutions after the impact will not be enough and even create chaos in the market.

Hence, in phased implementation aspects such as capping digital currency holdings for individuals and negative penalty on holding of digital currencies are being looked at to control this adoption shift. The Central Bank may also inject money in banks to ensure their abilities are not affected. It is interesting to also note the fact that digital currency might eventually eliminate the probability of bank runs as cash demands from customers reduce with adoption.

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