The global race to launch a central bank digital currency (CBDC) is gaining momentum with the Reserve Bank of India (RBI) among the frontrunners, going by statements emanating from the central bank. It is good that the RBI is moving forward in launching an electronic version of the sovereign currency, since that could well be the future of money, as digital adoption becomes all-pervasive. But the transition should be achieved in a gradual and calibrated manner, after examining all the consequences carefully. While an official digital currency can reduce the use of cash thus saving the cost of printing, transporting and distributing currency; improve financial inclusion and make payments more efficient, it can cause significant disruption to the banking system. It’s probably due to the unpredictability of the outcome that most countries are treading extremely cautiously in this regard. According to the IMF, around 100 countries are exploring the possibility of CBDC at some level, but only Bahamas has issued a CBDC as of now. China, Uruguay and Eastern Caribbean Currency Union are carrying out pilot tests while Canada has decided against issuing a CBDC for now, after pursuing the project for a while.

The RBI is adopting the right approach in introducing the CBDC in the wholesale segment first, with the rollout for retail users to follow later. The approach seems to be to ensure that India does not get left out of the CBDC movement, if it catches on. Wholesale transactions involve financial institutions and include inter-bank and cross-border transactions. It will be easier to transition these transactions to CBDC since the number of participants are fewer and they are under direct supervision of the central bank. The central bank will have to debit the account of the bank with net obligations to rest of the system and credit the account of the bank with net claim on the system. But implementing CBDCs in the retail segment will be far more challenging since these have to be made available to the public as a direct claim on the central bank; similar to paper currency. All other forms of digital money have an intermediary. RBI will have to decide the extent to which it will use banks in retail CBDCs. While banks can be used to onboard customers, do KYC compliance and service the CBDC accounts, it will be voluminous work, especially given our demographic profile.

The impact of sovereign digital money on current and savings account deposits of banks also needs to be taken into account. The effect on banks of customers shifting money from these low-cost deposit accounts into their CBDC wallets needs to be assessed. Also, money transfers through CBDC will be far easier compared to money in conventional deposits and there could be risk of flight of capital from the country in periods of economic crisis. RBI will also have to decide the extent to which it provides anonymity to the CBDC holders. Higher degree of anonymity, akin to cash, has policy trade-offs as it will aid money laundering and other illicit practices. Countries are veering towards providing anonymity to small-ticket CBDC transactions while keeping high valued transactions on the regulator’s radar. Finally, RBI needs to decide if a retail CBDC is required at this juncture given the stellar growth in digital payments in the country thanks to UPI, which is gaining traction among retail users.

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