What RBI needs to keep in mind for a new digital currency
- In Union budget presented few weeks ago, FM proposed to introduce digital currency in coming financial year.
Associated concerns with digital currency
- Slow and inefficient: compared to centralised ledger systems.
- Time to validate and settle transactions is high
- Number of transactions that can be handled is low.
- Account or token-based: Account-based framework, like bank deposits, links ownership with identity.
- Token-based framework, like cash, provides for greater anonymity.
- While former could increase risks for banks, latter raises concerns such as money laundering.
What will determine supply of CBDCs
- If the central bank decides to issue CBDCs above physical currency that it prints and injects every year into economy, it will lead to a significant expansion of its balance sheet.
- RBI can limit supply of digital currency by substituting it for some part of physical currency.
- It may result in capping digital currency in circulation, and amount that can be held by individuals and companies.
- It will limit its usage, at least in the initial years.
- It will also reduce risk of deposits shifting away from commercial banks,
- During financial distress, depositors will move from bank deposits to CBDCs and aggravate crisis.
Will digital currency be interest-bearing?
- It will effect financial system and monetary policy.
- Banks will face threat of deposits shifting to CBDC, and losing out on their source of funding.
- They may respond by raising funds at higher costs, which will impact their margin or lending rates, thus affecting credit demand.
- Considering these RBI may place a permanent “window” for banks, to help offset any asset-liability mismatches that may arise.
- There is usage of cash to contend with.
- Indian economy is still characterised by widespread use of cash.
- Limiting physical currency in circulation may have adverse effect economy that are predominantly dependent on cash as a medium of exchange.
- The large informal economy, especially the agricultural sector
- Central bank should explore to what extent benefits of issuing CBDCs will materialise in India.
- There is reason to be sceptical as India already has a robust payments infrastructure in place.
- The domestic payments ecosystem is characterised by low transaction costs and quick turnaround time.
- And, unlike China, there is healthy market competition. So to what extent the introduction of a CBDC will aid in further accelerating financial inclusion, facilitating low-cost transactions for low-income households, is debatable.