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As bitcoin’s popularity skyrocketed in India in 2017, the Reserve Bank of India (RBI) made it clear that it is uncomfortable with the non-fiat and volatile cryptocurrency. However, encouraged by the popularity, RBI executive director Sudarshan Sen said the central bank, in line with its global peers, is also examining the possibility of introducing its fiat-based cryptocurrency.

Exactly five years since, RBI has finally developed a concept note on the digital rupee, a central bank digital currency (CBDC). In its concept note, the RBI has proposed to issue two forms of CBDC—wholesale for interbank settlement and retail.

The first and foremost priority of CBDC is to compete with cash. In 2020, about 89% of all transactions by volume were estimated to be cash-based, a McKinsey report released in October 2020 showed. In FY22, currency in circulation was up 9.9% to over 31 trillion. And RBI spent 4,984.8 crore on the security printing of banknotes as against 4,012.1 crore in the previous year, the RBI annual report said.

With CBDCs, the worldwide central banks are talking about the risk associated with the backend settlement of physical currency, reducing the operation cost of dealing in cash and financial inclusion. “Not just the cost of printing but also the whole logistics and security around movement of cash is high," said Shilpa Mankar Ahluwalia, partner and head of fintech at Shardul Amarchand Mangaldas & Co.

A lot has changed in the past five years. With multiple digital payment options through NEFT, RTGS, IMPS, digital wallets, etc., India has come a long way in its digital payments journey.

UPI, then just a year-old payments system, did 104 million in transaction volume worth 9,600 crore in November 2017—processed 6,780.80 million transactions worth 11,16,438 crore in September 2022. India’s mass success of UPI has become a global case study now.

UPI is the single largest retail payment system in terms of volume of transactions. One of the initial objectives of UPI was to replace cash for low-value transactions. Transaction data analysis shows 50% of transactions through UPI were below 200, indicating its success, an RBI report dated December 2021 said.

So, how much does CBDC make sense in a country like India, where digital money is already widely accepted?

“Digital money is already super-efficient. CBDC can add value in conversion from cash to digital. Because people want to use cash for a certain reason, and that’s a mindset. UPI solves the use case. CBDC is only a cash replacement strategy," an official close to NPCI said, requesting anonymity.

“The segment where CBDC can add value is wholesale, where you can define money and its purpose. Today, cash has no colour. CBDC can actually colour the money, and it can be used for specific purposes," the official said. In its concept note, RBI has talked about the programmability feature of CBDC, which means it can be programmed to achieve purposes like ensuring it is only spent for a particular purpose, etc.

The second biggest use case where industry experts believe CBDC brings huge change is cross-border payments, where UPI is also venturing. “The big advantage for India will be cross-border payments, which are expensive as there is a lot of time, cost and settlement involved. But, to make CBDCs workable for cross-border, it will require a lot of integration with global financial institutions," Ahluwalia of Shardul Amarchand Mangaldas said. “While the phase 1 launch will look into CBDC’s role domestically, phase 2 will be real value for India in cross-border payments."

On the retail side, the biggest issue is going to be the anonymity part.

In the concept note, the RBI understands that to make CBDC a success, 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, the RBI stated.

“Surprisingly, they have weighed anonymity as a significant point. In 2017, RBI was lambasting virtual currency for promoting anonymity. Here, they say we should promote anonymity and preserve privacy. That way, there is a clear contradiction," said a partner at a law firm which has represented several cryptocurrency exchanges in the past.

The industry believes that RBI is a little vague on the part where it says there will be KYC/AML linked to every wallet. “If somebody pays, let’s say, 2,000 to a vendor to get CBDCs to spend without a KYC, then it could be anonymous. But if there is KYC needed to even open the account and use it, then it is like Aadhaar-like situation where people will argue Aadhaar is private or not private," the partner at a law firm added.

“In our country, law and order is very weak. This entire system should change together. If this government can let go of many things, change the law and bring anonymity to the digital rupee, then only it will see mass adoption," the official quoted above said. “Otherwise, we will end up with a multi-layer system where cash, CBDC, and digital money will exist with very little incremental value-add," he added.

Experts said nothing clearly states what benefits CBDC wants to achieve.

“It’s more like because there was one policy statement, followed by a budget announcement, and that all other central banks are exploring this, the RBI is also exploring. The concept note is a lot more open in terms of design and technology choices and whether it will be on a decentralized blockchain. Back in 2017, there was a question of how decentralization and centralization be achieved at the same time?" the law firm partner added.

Interestingly, there is no call for consultation and feedback either. It’s just a concept note, saying that this is what RBI is thinking. Looks like RBI may have to wait for a major country to roll it out first to gain some learning. RBI has mentioned that since there is no precedent, they will have to weigh the options carefully.

Summarizing the note, Kenneth Rogoff, a Harvard economics professor and a former chief economist for the IMF, told Mint, “The RBI’s concept note seems very much in line with what other central banks are saying, carefully laying out the issues in very broad strokes without really being too specific about what choices the RBI will ultimately make. India has an important advantage over most countries in that it is far ahead in its identification systems and protocols which are the heart of any attempt to have a retail Central Bank Digital Currency. While it definitely makes sense to be exploring the issue of implementing a CBDC – virtually every central bank is doing it -- it remains to be seen whether the functional advantages of a CBDC cannot be better achieved by improving existing current systems. One key question is whether a CBDC will make it harder or easier to balance the individual’s right to privacy and the State’s right to enforce taxes and regulations."

ABOUT THE AUTHOR

Arti Singh

Arti Singh has been a business journalist for 15 years. Over the last five years, she has closely tracked India's fintech space and written important deep-dive stores. As deputy editor, she covers the intersection of finance and tech at Mint.
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