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Does India really need a central bank digital currency?

Each country has different goals and ours can be achieved better through existing tools than a CBDC

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Photo: Mint

Global interest in central bank digital currencies (CBDCs) is on the rise, with 80% of all central banks investigating their issuance and half having progressed past research to running pilots. In an article last year, I applauded this trend believing that CBDCs represented the best of both worlds—the programmability of cryptocurrency and stability of fiat currency.

But the more I read about this new form of digital currency, the clearer it became to me that any decision to issue a CBDC would be both nuanced and complex. While it might seem like just another flavour of virtual money, the fact that it is issued by a central bank puts a whole new spin on it.

To figure out why this is the case, we need to understand how our modern two-tiered banking system works—and, in particular, the symbiotic relationship between public and private money.

Simply put, private money is the money in our bank accounts—the deposits we hold with commercial banks that are their unsecured liability and which can be redeemed in the form of public money. Public money issued by central banks is the safest and most liquid form of money.

The ability to redeem private money in the form of central bank currency and to acquire the same public money in times of stress (along with deposit insurance, where it exists) is broadly what gives the banking system its stability and interoperability. The fact that multiple commercial banks can use private money in a variety of ways gives the system its innovative strength and diversity. The relationship between the two makes our modern banking system what it is.

Central banks also issue public money to the retail public by way of banknotes and coins. This is how we all get to put a small amount of safe, liquid central bank money in our wallets. Once issued, CBDCs will be another form of retail public money.

Central to the decision on issuing a CBDC is figuring out how it will fit into our finely balanced monetary system. In countries where public holdings of cash are rapidly declining, CBDCs are being seen as an alternative to cash. However, until the risk of technology failure is properly mitigated, CBDCs will offer nowhere near the same psychological comfort as cash. Replacing private money with CBDCs will, on the other hand, put the stability, diversity and innovation of our dual-monetary system at risk.

Most central banks are thinking of issuing a limited quantity of CBDC and placing thresholds on the amount any one person can hold. Some are keen to take advantage of CBDC programmability, making them interest-bearing so that they can have a more direct way to influence monetary policy. Each option involves trade-offs that require deep consideration.

Central banks have different motivations for introducing CBDCs. For those that fear the influence big fintechs have on their economies, CBDCs are a way to wrest back control. In China, while the meteoric rise of Alipay and WeChat resulted in the proliferation of digital payments, this happened outside the central bank’s sphere of control. China’s CBDC is likely to bring digital payments back under the control of its central bank.

Countries that do not have a digital fast payment system see CBDCs as a way to promote digital payments, forcing central banks to catalyse digital innovation where fintechs and banks have failed. For other countries, the allure of CBDCs is their programmability and the fact that self-executing contracts and programmable money could easily be used for tax collection and insurance.

Developing countries see CBDCs as a way to bank the unbanked. Since CBDCs are issued directly by the central bank, they can, unlike other digital money, be used by citizens who don’t have bank accounts. This is even relevant in countries like India where, despite a sharp increase in new bank accounts, 20% still don’t have one. Which begs the question: Does India really need a CBDC?

India already has a fast payments system that performs well at scale. If required, all it will take is a little extra engineering to bolt programmability onto it—be it for smart contracts or to program end-use and time restrictions into payments. We do not need to issue a CBDC just to obtain those benefits.

Unlike China, where the digital payment system was built by big tech companies outside the regulatory rails of the central bank, the Unified Payments Interface (UPI) was built by and under the supervision of the Indian banking sector regulator. We don’t need to issue a CBDC to regain control—we never lost it in the first place.

This leaves banking the unbanked as a goal. Today, 80% of adult Indians have bank accounts. Before we think of issuing a CBDC to those who don’t, we need to ensure that those with bank accounts are actually using them. Of the 500 million bank accounts in the country, no more than 35% are active. This means that despite its success, UPI still has to cover 65% of its addressable market.

Rather than rolling out a new digital currency to cover those outside the banking system, it would be better to use our resources to get those who have bank accounts to use them more actively. Using a series of carefully designed initiatives, we should be able to incentivize them to pay online. It is only once we’ve done this that we should think of getting those without bank accounts to use digital payments. I love the technological promise of a CBDC. But I’m no longer sure it’s needed in India.

Rahul Matthan is a partner at Trilegal and also has a podcast by the name Ex Machina. His Twitter handle is @matthan

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Updated: 12 Jul 2022, 10:34 PM IST
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