India shouldn’t launch a digital currency in haste

While the US central bank chose not to reveal its hand on a launch of its digital currency, opting to tread carefully, the Economic Affairs Committee of the House of Lords in the UK - the equivalent perhaps of the Parliamentary Standing Committee on Finance in India - was clearer last month. It reckoned that there would have to be a lot of convincing to do before any such plans could be approved. Broadly, the committee was not convinced that there was a case for digital notes or coins to be issued by Bank of England that was set up in the year 1694. Like in the US, a formal consultation with the Treasury and the Bank of England on this “national" infrastructure project will be kicked off first. The earliest date -- if the UK CBDC proposal is found to be operationally and technically feasible -- would be the second half of this decade, according to the fiscal and monetary arms of the country.

India’s central bank – criticized often in the past for a conservative approach to technological developments – and Prime Minister Narendra Modi-led government appear not as fazed as their global peers on what will be the biggest disruption in the history of currency. Rather, with finance minister Nirmala Sitharaman’s announcing in the Union budget that India will have a digital rupee and a law for the digital currency, it is fait accompli.

The rationale for racing ahead of the US and the UK on CBDC is the boost that the launch of this currency -- the Modi government imagines -- would give to India’s fast digitizing economy powered by the impressive pace of growth of digital transactions.

The benefits of digital currency, such as lower transaction costs – including lower printing and distributing costs for the central bank and the government — and likely faster and cheaper transfer of funds, have been acknowledged by most central banks. No question about that. As also the potential to reach money into the hands of the unbanked.

However, India’s rush to announce the digital rupee is baffling.

Surely, it should be a worry that in a country with uninformed investors and a record of low financial literacy, there has been insufficient debate and consultation on a digital currency and its potential impact on households and businesses. Major central banks are trying to understand what could be the impact of digital currencies on financial institutions such as banks, worried that what will happen if, for instance, deposits move out of banks to digital currencies in a crisis. It will raise banks’ costs of raising deposits besides posing the risk of reduced credit. There will also be ramifications, not insignificant, for the conduct and efficacy of monetary policy. Or, in other words, financial stability.

There are also concerns over cyber-security and, more importantly, privacy protection, and the access of central banks to data on transactions by individuals.

The US Fed for one, in its discussion paper, talks about the policy challenge of ensuring that the CBDC would not violate the privacy of Americans and the ability of the government to combat illicit finance. These are challenges which Indian law makers, regulators and experts too must discuss with greater urgency.

British law makers appear to have far more clarity on these matters. The head of the UK House of Lords Economic Affairs Committee said a few weeks ago that the panel found that the potential benefits of a digital pound, as set out by the Bank of England, to be “overstated". It should be of interest to Indian law makers that this committee concluded recently that the idea of a digital currency was a solution in search of a problem.

Yes, the glamour and appeal of launching the digital rupee are hard to resist. New Delhi and the Indian central bank seem to have reached a point of perfect harmony and agreement. That is also reflected not just in the approach towards launching digital notes given the concerns of the RBI on crypto-currencies, but in the way the government has chosen to tax digital asset transactions at a high rate, rather than the blunt tool of a ban on crypto-currencies.

The key though, as US Fed chief Powell put it so well, is to get the digital currency right rather than to be the first to market it. Should that not be the primary aim for India too? Getting the concept wrong can have heavy costs, and is something that Indian policy makers should be mindful of.