The merits of an RBI digital currency outweigh risks

Relevance:  Future of Central bank Digital currencies in India

Synopsis: Launching a CBDC by RBI entails many risks while offering many opportunities too. A thorough assessment is the need of the hour. An analysis of the risks, concerns and benefits of CBDCs.

About CBDC

• Significance and Risks associated with CBDC

Does India need a CBDC?

Justification for a CBDC in India is given on the following two grounds:

1]. Helps in becoming more globalized: First, becoming more globalized in terms of international trade and investment are critical to India’s national interests. With more than 50 countries looking into the possibility of introducing their own CBDCs, the future of globalization is CBDC-based.

• Shifting from SWIFT: Also, the current international payments system based on SWIFT is costly in terms of both time and money. So, within no time the international trade, investment and even remittances will look to shift to multi-country CBDC networks. In order to remain globally competitive under these circumstances, India will need to have a CBDC.

2]. Helps in domestic digitalization: An Indian CBDC can also help domestic digitalization. Current efforts at financial inclusion have seen very limited participation by private-sector banks, with the bulk of the burden being placed on public sector banks at considerable loss to them. Since the for-profit NUE mechanism is also bank-account-based, it might strengthen the divide. This will make inclusive digitalization a challenging project. CBDCs may provide an alternative to the NUE (New Umbrella Entities) by working outside the banking sector, like through the postal system.

Concerns

1. Domestic demand for other CBDCs:The possibility of CBDCs of other countries becoming international currencies is a real concern. This may lead to substantial domestic demand for these currencies in India, resulting in possible dollarization-like scenarios.
2. Data security issues: Given India’s recent conflicts with China, the rise of a cross-border digital yuan could also present issues of data security, as digital currencies might provide their issuer with detailed information of transactions.
3. Disintermediation risks: Risks of disintermediation of the banking sector and the possibility of bank runs in the event CBDCs prove to be more attractive than bank deposits.
   • Disintermediation means reduction in the use of intermediaries between producers and consumers.
4. Liquidity problems: A move away from bank deposits, leaving banks with liquidity constraints, would require more interventions by the central bank by way of liquidity provisions.
5. Further, while CBDCs are expected to provide a safer alternative to private virtual currencies, it is still unclear how this will be achieved. Would such private currencies be prohibited, or would the CBDC coexist as a competitor to them?

Way forward

The best way to deal with this is to establish global protocols on the cross-border use of CBDCs. In order to have a say in these international settlements, it will be very useful for India to have a credible and working CBDC.

Conclusion

The adoption of CBDCs is the only economic development that is happening at a global scale without any historical precedent to fall back on. Hence, it is very important that every aspect of this development is scrutinized before implementation.

Terms to know:

• New Umbrella Entity (NUE)
• UBI
• SWIFT
• CBDC