How the RBI's digital currency can help economy

If a CBDC becomes a significant proportion of all money, it can make monetary policy more effective.
If a CBDC becomes a significant proportion of all money, it can make monetary policy more effective.


More than 50 central banks are planning to issue CBDCs worldwide.

Readers of a certain age group might remember Ramon Bonus Stamps. It was a hugely successful loyalty programme in the late 1960s. You got some stamps on every purchase from participating retailers, and could redeem them for a gift after accumulating a certain quantity. Some people sneakily exchanged them for real cash too. At its peak, it is said that more of these bonus stamps were printed than by the postal department. Its success spawned enterprising businesses that started printing these stamps for circulation, which then threatened to become a parallel currency. A deluge of fakes soon led to the scheme shutting down. Of course, subsequent technologies like holograms and later QR-code-based authentication could deter counterfeiters. Not surprisingly, loyalty programmes have not only survived, but flourished. You can earn and accumulate points on purchases of almost everything, and then redeem these points for more merchandise or donate them to designated charities. The loyalty of the customer is now earned not only on brands or products, but even on baskets of goods or aggregate purchases by the reward of points. These points are sometimes transferable, even exchangeable between big retailers. Typically, you store these loyalty points in digital wallets and can also top up your balance with ‘real money’. Everyone from Amazon and Airtel to Ola and Uber offers a wallet. But what is in this wallet cannot become a parallel currency, like the Ramon Bonus Stamps of yore. This is because it would be deemed illegal, as it has no official state authorization (or fiat). Even otherwise, its acceptability is going to be limited.

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Imagine different currencies competing for dominance in usage without any sovereign backing. Such a free market for competing currencies exists only in technical papers and in Utopia. Recently, even the megacorp Meta (owner of Facebook) gave up its project to privately issue a currency called Diem. So far in the modern world, only sovereign-backed fiat currencies have universal acceptability. Such a currency can be debased by irresponsible monetary or fiscal policy and inflation, or abruptly shut off by actions like demonetization. The emergence of distributed ledger technology (called blockchain) led to the creation of Bitcoin, which aims to be a currency that is not controlled by a central authority, with no risk of being debased. Can it become an alternate currency, if not replace fiat money?

The function of money as a medium of exchange is based on its general acceptance by all, sort of like a positive feedback loop. As in language, more people speak English because more people speak English. But mostly, the universal usage and acceptance of a national currency is imposed by fiat, and by making alternatives illegal. Will Bitcoin become so popular that everyone will switch over to it? Will it face a backlash from sovereign powers? Bitcoin rebels hope to establish a medium of exchange, become popular, and get the better of currencies issued by sovereigns. That is a pipe dream. Because sovereigns, if threatened, will go to any length to suppress cryptography-based currencies. In the meantime, blockchain-based tokens (or assets) have had a field day as candidates for speculation. This asset class also led to the proliferation of crypto exchanges, which assured traders protection from counterparty risk. That protection turned out to be fragile and the FTX meltdown has served as a cautionary tale. However, the underlying promise of the technology of distributed ledger-based authentication remains alive and kicking. Bitcoin as a concept is still something that central banks have to reckon with.

That is the background to why many central banks are wading into cyberspace to issue blockchain-based tokens, also called central bank digital currencies (CBDCs). The Bank for International Settlements reports that more than 50 central banks are planning to issue CBDCs worldwide, and in three years, nearly 20% of all currency could be digital cash. This is different from payments interfaces like India’s UPI, which are just mechanisms that instantly move money among bank accounts. This is digital cash that will reside directly in an account with the central bank. India is among the early starters, having started pilot trials of digital cash for wholesale and retail usage in limited geographies.

Unlike Bitcoin, the CBDC ledger is centralized, so it offers no anonymity, although for small-value transactions the Reserve Bank of India says that no central records will be maintained. RBI’s digital tokens can be exchanged using smartphones and QR-code scans. Centralized ledgers will keep track of transfers and maintain a digital trail. Like paper cash, these tokens represent a liability of the central bank, but cannot be used namelessly. If a CBDC becomes a significant proportion of all money, it can make monetary policy more effective with better transmission and the use of zero or negative interest rates. A CBDC also allows governments to target their spending and put purchasing power in selected wallets, making fiscal policy more effective. Tax collection also improves, since all transactions are ‘visible’ in real time. Trade payments are faster and international transaction costs are lower. And, of course, much paper is saved. But not only is anonymity lost, closer alignment of the central bank and government can erode monetary policy autonomy. Into this brave new world, India takes a baby step.

Ajit Ranade is a Pune-based economist.

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