CBDCs: RBI must take a leaf out of US Fed’s consultative approach

The paper lists the pros and cons of CBDCs and traces the developments leading up to the case (clamour?) for CBDCs; the crypto mania that marked the latter half of 2021, for one. But that is only one reason. There are other drivers as well – the declining use of physical cash (a trend reinforced by the covid-19 pandemic), growing digitization, convenience, the desire of central banks to further loosen monetary policy, encompassing within that the pursuit of negative interest rates, instead of being constrained by the zero bound (the fact that nominal interest rates cannot fall to below zero).

The more important reason, perhaps, is to ensure central bank currencies, or fiat currencies, remain relevant and are not made redundant by the growing popularity of competing virtual currencies. CBDCs, for instance, could provide households and businesses a convenient, electronic form of central bank money, with the safety and liquidity that such money would entail; give entrepreneurs a platform on which to create new financial products and services; support faster and cheaper payments (including cross-border payments); and expand consumer access to the financial system (read, financial inclusion).

These are benefits that are not to be scoffed at. Unfortunately, as with everything else in life, CBDCs are not all win-win. There are risks, or rather, uncertainties, as well. CBDCs could adversely affect the financial-sector market structure, the cost and availability of credit, the safety and stability of the financial system, and the efficacy of monetary policy.

It is not surprising, therefore that the Fed is emphatic that it “will only take further steps toward developing a CBDC if research points to benefits for households, businesses, and the economy overall that exceed the downside risks, and indicates that CBDC is superior to alternative methods. Furthermore, the Federal Reserve would only pursue a CBDC in the context of broad public and cross-governmental support."

The Fed’s paper mirrors much of what the Reserve Bank of India (RBI) deputy governor T. Rabi Sankar, said in his landmark speech, Central Bank Digital Currency – Is This the Future of Money in July last year. This is not surprising since the potential benefits and risks of CBDCs are common to all jurisdictions with modern financial systems.

Where the Fed’s approach differs from that of our own RBI is in its apparent willingness “to conduct targeted outreach and convene public forums to foster a broad dialogue about CBDC". The Fed lists 22 questions to which it has sought comments from the public and adds “all public questions and comments on the discussion paper will be made available publicly".

This is in keeping with the Fed’s more democratic and consultative style of functioning. We saw this in the context of the review of the Fed’s monetary policy framework when, for well over a year it engaged in a number of outreach ‘Fed Speaks’ programmes across the country, before shifting to the new regime targeting ‘average’ rate of inflation in August 2020. Contrast that with the RBI’s ivory-tower approach. The review of our own monetary policy framework in 2021 was a closed-door exercise between the RBI and the government!

Likewise with discussion papers. The RBI does call for comments, but these are not made public. What we get, instead, is a terse statement saying the RBI has examined the comments received. But no one is any the wiser either about the suggestions made or how these impacted the final decision. It’s as though the Oracle has spoken! The central bank’s recent proposal for the resolution of PMC Bank involving the interests of thousands of depositors is a case in point. But that is not how policy should be framed. We need a free and frank exchange of views. With complete transparency.