Purushottam Anand, an advocate and the founder of Crypto Legal, discusses the recent announcement in the Finance Bill 2022 about the introduction of CBDC, its implications, and concerns regarding the banking system and private cryptocurrencies...
Central Bank Digital Currency (CBDC) is increasingly being referred to as the ‘future of money,’ which is also evident from the fact that 87 countries representing 90% of the global GDP are currently exploring digital currencies. China was the first major economy to create its own digital currency in April 2021 and the Chinese Central Bank has recently launched digital Yuan wallets for Android and iOS aiming towards an overall domestic use of the CBDC.
India has also announced that a digital rupee will be introduced by its Central Bank i.e. the Reserve Bank of India (RBI) in the coming financial year (April 2022 to March 2023). The Indian Finance Minister, in her speech in the Parliament, emphasized that CBDC will give a ‘boost to digital economy’ and will also ‘lead to a more efficient and cheaper currency management system’ and, therefore, proposed to introduce a digital rupee using ‘blockchain and other technologies.’ Accordingly, the Finance Bill, 2022 was introduced which, inter alia, proposes to insert a clause (aiv) in Section 2 of the Reserve Bank of India Act, 1934. The said clause increases the ambit of the term “bank note” to include notes in digital form. Though the details as to the architecture, functionality and underlying technology of Indian CBDC are not yet known, this new clause suggests that it would mirror the rupee in a digital form and can be exchanged for fiat currency i.e. bank notes which are in physical form.
India witnessed an exponential growth in the adoption of digital payments during the last few years and recorded 40 billion transactions worth more than a quadrillion rupees in 2021. CBDC offers many additional benefits which are not supported by the existing payment architectures/solutions. Firstly, the settlements in CBDC will take place instantly which will, for all practical purposes, render any issues relating to settlement risks to the counterparty banks wholly redundant. Cross-border settlements in CBDC will take place seamlessly irrespective of any time-zone difference, provided both the countries have their CBDCs. The introduction of CBDCs also envisages settlement of transactions in the Central Bank’s ledger directly which will not require the involvement of multiple banks and will reduce transaction cost. Secondly, it will also save substantial amounts which are currently spent in printing, transportation and distribution of fiat currency. Thirdly, CBDC can help in automating tax collection and can also be a valuable tool in distributing subsidies, stimulus and other government support directly to the wallets of the citizen.
The benefits and usability of CBDCs, however, will largely depend on the specific features and model adopted by the RBI. CBDC may be designed for retail or wholesale or for any other specific usage; it may be distributed by the Central Bank directly or through the banks as in the case of fiat currency, and it may use different underlying technologies like blockchain or existing financial technology. Even though the announcement of the introduction of CBDC has already been made by the Finance Minister in the Parliament, the RBI has refused to reveal any timeline or other details including the technology which will be used in RBI’s CBDC. RBI’s Executive Director, Mr. T Rabi Shankar, has stated that the ‘technology choices are open’ and RBI’s CBDC may not necessarily be on the blockchain. Thus, India’s CBDC is still a ‘work in progress’ with very limited details available in the public domain.
CBDC vs. Banking System
CBDCs can significantly impact the monetary policies, existing banking system and macroeconomic policies if the model of the CBDC is not carefully calibrated. CBDC issued by the RBI will mitigate the risk of default on payments or withdrawal limits that depositors face while dealing with commercial banks during the financial crisis caused by fraudulent loans and stressed assets. For example, RBI imposed a withdrawal limit of INR 50,000 on PMC Bank accounts in September 2019 and on Yes Bank accounts in March 2020. On the other hand, CBDCs being a legal tender will not be an interest-bearing instrument. Banks may also need to increase interest rates to attract consumers to opt for depositing in banks over keeping their money safely in RBI issued CBDC. This in turn will also impact the profitability and lending powers of the banks.
Out of the total mobile users in India, more than 35 percent of users (440 million out of a total 1.1 billion) don’t have smart-mobile phones and rather use feature phones. RBI, in December 2021, announced a payment product that can be used from feature phones. The model, design and technology of CBDC should also be conscious of financial inclusion and must ensure that this payment solution is also accessible through a feature phone.
CBDC and Cryptocurrencies
Central banks’ interest in CBDCs seems to correspond with the popularity of private–not issued by any sovereign–cryptocurrencies. It is difficult to believe that this is a mere coincidence. Despite the inherent foundational and philosophical contradictions between the two, central banks seem to be optimistic about replacing private cryptocurrencies with the government-backed CBDCs. Unlike private cryptocurrencies which were introduced to avoid the need for any centralized authority and restrict governments’ power to manipulate the valuation of currencies, CBDCs are issued by central banks and backed by the sovereign just like fiat money. Cryptocurrency enthusiasts particularly condemn inflation caused by excessive printing of money by the government and CBDC cannot conceivably provide an answer to this fundamental criticism of fiat currency. Ironically, central banks are claiming to launch CBDCs ‘to protect citizens from private cryptocurrencies’, while private cryptocurrencies are mushrooming to provide shelter to people from the inflation caused by monetary policies of the central banks!
Since CBDC is proposed to be exchangeable with fiat INR, the inflationary trajectory of CBDC is likely to be the same as that of the Indian Rupee. Launching a CBDC with deflationary properties will have its own challenges and the RBI will have to design a detailed framework on how the digital rupee will get converted into fiat rupee. CBDC is, however, likely to reduce the volume and usage of stable coins like USDT and USDC which are being predominantly used for payments and as a bridge between fiat and private cryptocurrencies.
Though one implied purpose of issuing CBDC is to divert the attraction of citizens towards private cryptocurrencies, interestingly, CBDC might also help in the adoption of private cryptocurrencies by people who are staying away from cryptocurrencies due to general scepticism and suspicion towards blockchain and cryptocurrencies which to a large extent has been fuelled by the regulatory uncertainty. Being issued by the RBI, CBDC will integrate well with the existing financial system and is likely to be user-friendly for mass adoption.
RBI must also consider the privacy and security concerns of citizens while designing the framework of CBDC. CBDC will significantly enhance the control and surveillance capabilities of the RBI and the Government. The State authorities will be able to track every penny spent by the citizens and will be able to block or freeze any CBDC wallet directly without the involvement of any commercial banks. Comparing it with the existing payment options, cash provides anonymity and at least small transactions below a certain threshold cannot be tracked as they don’t require submission of the PAN (Permanent Account Number) or other KYC details. Considering the limited information about the technology and regulatory approach, it is difficult to comment right now whether a similar exemption will be extended to small transactions in the CBDC regime.
Excessive surveillance power may also be misused for political and other reasons and it will become much easier to target wallets belonging to particular individuals/groups. Regulators may also prescribe and impose restrictions relating to the purpose of use – e.g. stimulus received cannot be spent on alcohol etc., or prohibit the transfer of funds to certain individuals or groups. One interesting recent example in this context is the powers given to banks in Canada to freeze funds ‘suspected of being directed to the protestors’ and the Federal Policy there has blacklisted Bitcoin addresses allegedly belonging to protestors and has directed companies to cease transacting with such addresses. If governments can try to block bitcoin addresses, specific and targeted restrictions of this kind may become more frequent than ever under the proposed CBDC regime.
Even before the announcement by the Finance Minister, RBI in Dec 2019 indicated that it is inclined to initially go for a basic model of CBDC which will help it assess the impact of CBDC on monetary policy and existing banking and payment systems. Some caution is certainly required in finalizing the model of CBDC for India, but what is equally required is optimism towards a plethora of opportunities that CBDC offers. RBI is expected to follow a balanced approach of cautious optimism to get the best out of its CBDC endeavour.
Purushottam Anand is an Advocate and Founder of Crypto Legal.
Suggested citation: Purushottam Anand, Central Bank Digital Currency Introduction in India: Impact and Concerns, JURIST -Professional Commentary, March 04, 2022, https://www.jurist.org/commentary/2022/03/Purushottam-Anand-cbdc-introduction-india-budget/.
This article was prepared for publication by Shifa Qureshi, a JURIST staff editor. Please direct any questions or comments to her at firstname.lastname@example.org
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