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Scope for Central Bank Digital Currency in India

The rise of digital currencies has reached a pivotal stage with the advent of stablecoins, which combine the advantages of crypto currencies with value stability by being tied to traditional assets. In India, the digital finance landscape is undergoing significant transformation through two concurrent developments: the Reserve Bank of India’s Central Bank Digital Currency (e-rupee) and rupee-backed stable coins. The Bank for International Settlements highlights that digital currencies have the potential to reduce transaction costs by up to 50%, making them appealing to both businesses and individuals. At this critical point, the coexistence of the e-rupee and rupee-backed stable coins could foster a more inclusive and efficient digital financial ecosystem, provided robust regulatory frameworks are in place.

About:
Central Bank Digital Currency (CBDC) is a digital version of a country’s fiat currency, issued and regulated by the central bank. It provides a secure, efficient, and seamless alternative to physical cash while reducing the costs associated with printing, distribution, and storage. Additionally, it addresses risks such as counterfeiting and theft.

CBDCs aim to enhance financial inclusion, simplify cross-border payments, and facilitate the transition to a digital economy. Their design is carefully crafted to minimize disruptions to the existing financial system.

Types of CBDC (e-Rupee):

1. Retail CBDC:
   • Purpose: Designed for private sector users, including individuals and businesses. It acts as an electronic equivalent of cash for everyday retail transactions.
   • Features:
     • Serves as a direct liability of the central bank.
     • Ensures safe and secure access to money with 24/7 availability.
     • Enables real-time or near real-time payment settlements.
2. Wholesale CBDC:
   • Purpose: Primarily used for interbank transfers and large-scale financial transactions, such as bond settlements and nostro transfers.
   • Features:
     • Limited to select financial institutions.
     • Enhances settlement systems by improving their security and efficiency.

Key Benefits of Central Bank Digital Currency (CBDC)

Enhanced Financial Inclusion

• CBDCs can extend banking services to unbanked and underbanked populations by minimizing reliance on physical bank branches.
• Mobile-based digital wallets enable individuals to access financial services at their fingertips.
• The Reserve Bank of India (RBI) has proposed introducing offline functionality for CBDC-R, allowing transactions in areas with limited or no internet connectivity.

Reduction in Transaction Costs

• CBDCs can significantly lower domestic costs by eliminating intermediaries, as well as the expenses associated with printing and transporting currency.
• For instance, the cost of handling ₹100 notes amounts to ₹15–₹17 over their four-year lifecycle, as per market estimates. These costs can be reduced with CBDCs.

Improved Monetary Policy Implementation

• CBDCs allow central banks to monitor money flow in real time, facilitating precise monetary policy measures such as targeted liquidity injections.
• This can help address issues like hoarding and black-market activities, improving the effectiveness of policy transmission.
• In 2022, the RBI showcased its wholesale CBDC pilot (e₹-W) to enhance interbank settlements and liquidity management.

Enhanced Transparency and Reduction in Illicit Activities

• CBDCs, with their traceable transactions, can combat corruption, tax evasion, and financial crimes by providing better oversight of funds.
• The Financial Action Task Force (FATF) estimates global money laundering to amount to trillions of dollars annually, with less than 1% of illicit financial flows being recovered.
• CBDCs could help reclaim a significant portion of these funds through enhanced transparency. India’s implementation of e-invoice systems aligns with such anti-evasion efforts.

Boost to Cross-Border Payments

• CBDCs have the potential to modernize and streamline cross-border payment systems, enabling faster, more secure, and cost-effective international transactions.
• The Bank for International Settlements (BIS) notes that CBDCs can significantly lower remittance costs.
• India’s G20 initiative on digital public infrastructure focuses on reducing global remittance costs by 2027. The m-CBDC Bridge Project, involving Thailand, Hong Kong, and the UAE, has demonstrated near-instant settlements through CBDCs.

Fostering Innovation in the Financial Sector

• The introduction of CBDCs promotes fin tech innovation by creating demand for new payment solutions and services.
• India’s Unified Payments Interface (UPI) has already driven advancements in the e-commerce and fintech sectors, and CBDCs could build on this foundation.
• For example, CBDCs could integrate with IoT systems for micropayments in smart cities, accelerating India’s smart infrastructure goals.
• As of 2021, India boasted a fintech adoption rate of 87%, the highest globally, compared to a global average of 64%. CBDCs could further amplify this trend.

Economic Resilience and Crisis Management

• CBDCs provide a reliable alternative during crises such as natural disasters or pandemics, where physical cash may be inaccessible.
• Digital wallets powered by CBDCs can facilitate seamless and real-time disbursement of welfare funds.
• During the COVID-19 pandemic, logistical challenges in handling physical cash delayed global relief efforts. A functional CBDC system could have expedited these transfers in alignment with India’s humanitarian aid policies.

Support for De-Dollarization

• CBDCs can reduce dependence on foreign currencies for trade and reserve management, thereby bolstering economic sovereignty.
• For example, Russia’s introduction of the digital ruble aims to reduce its reliance on the US dollar amidst international sanctions.
• In India, the RBI’s wholesale CBDC pilot for rupee-based cross-border trade supports the goal of internationalizing the rupee, aligning with initiatives like the Rupee-Ruble Agreement.

Key Concerns Associated with CBDC

Cyber security and Privacy Risks

• CBDCs heighten the risk of cyberattacks on digital financial infrastructure, posing threats to national financial security.
• Centralized systems become attractive targets for hackers, as demonstrated by the 2020 SolarWinds cyberattack, which compromised critical financial systems.
• The rising number of cybercrimes, such as data breaches and online theft, exacerbates these concerns.

High Implementation and Maintenance Costs

• Establishing and maintaining CBDC infrastructure demands substantial financial investment and advanced technical expertise.
• These costs can strain central banks, particularly in developing nations with limited fiscal resources and competing developmental priorities.
• For example, the development and launch of the eNaira reportedly imposed significant financial burdens on the Central Bank of Nigeria (CBN).

Impact on the Commercial Banking System

• CBDCs could disrupt traditional banking by diverting deposits away from commercial banks to central bank accounts, reducing banks’ ability to lend.
• The Bank of England estimated that CBDC adoption could shrink bank deposits by 4% to 12%, potentially creating liquidity shortages.
• To address these gaps, banks might need to borrow from wholesale markets, increasing their funding costs, or limit lending, which could negatively impact economic growth.

Limited Technological Readiness

• Successful CBDC deployment requires robust technological infrastructure, which many countries currently lack.
• As of 2023, around 45% of India’s population, or approximately 665 million people, remain without internet access. Moreover, with digital literacy at just 25% (NITI Aayog), widespread adoption of CBDCs poses significant challenges.

Cross-Border Regulatory Challenges

• Incorporating CBDCs into global payment systems faces numerous hurdles, including regulatory, technical, and geopolitical issues.
• The lack of standardized frameworks for CBDC interoperability complicates international trade and financial transactions.
• For instance, the m-CBDC Bridge Project operates on a completely different framework compared to the digital euro or digital rupee.

Macroeconomic Risks and Dollarization

• In developing economies, CBDCs could heighten dollarization risks if foreign CBDCs dominate domestic financial systems.
• A recent study highlighted that smaller economies are especially vulnerable to this risk if neighbouring nations introduce stronger CBDCs.
• This could erode monetary sovereignty, as seen in El Salvador’s challenges with Bitcoin adoption.

Measures to Effectively Implement CBDC in India

Building Robust Digital Infrastructure

• Strengthening digital infrastructure, particularly in rural areas, is essential for CBDC adoption.
• Initiatives such as BharatNet should be expedited to improve broadband connectivity nationwide.
• With only 25% of rural India digitally literate, targeted training programs and investments through Common Service Centres (CSCs) can bridge this gap.
• Collaboration with private telecom operators can enhance last-mile connectivity, ensuring broader access.

Ensuring Cyber security and Data Privacy

• Developing a comprehensive cyber security framework is critical to safeguarding CBDC systems from potential threats.
• Advanced encryption technologies and AI-based monitoring systems should be employed to secure digital transactions.
• The Reserve Bank of India (RBI) can collaborate with CERT-In (Computer Emergency Response Team of India) to establish real-time threat detection and response mechanisms.

Integrating with Existing Financial Ecosystems

• CBDCs should complement, not disrupt, the current banking and payments systems.
• A tiered CBDC model can be implemented, where commercial banks act as intermediaries for distribution and account management.
• The RBI’s pilot project, which integrates UPI for retail CBDC transactions, illustrates how existing platforms can ensure smooth integration.
• Linking CBDCs with Aadhaar and Jan Dhan accounts can enhance financial inclusion, reduce redundancy, and optimize resource utilization.

Promoting Public Awareness and Education

• A well-structured awareness campaign is crucial to educate citizens on the benefits and use of CBDCs.
• The RBI and the National Payments Corporation of India (NPCI) can collaborate to conduct workshops, online training modules, and community outreach programs.
• Successful initiatives like DigiDhan Melas for promoting digital payments can be replicated to build trust and understanding among the public.

Creating Offline CBDC Capabilities

• Developing offline functionality for CBDCs is vital to ensure accessibility in areas with limited or no internet connectivity.
• Technologies such as NFC-enabled smart cards or mobile wallets can facilitate offline transactions.
• The RBI’s ongoing offline retail CBDC trials are a positive step in building an inclusive and resilient CBDC ecosystem.

Establishing Interoperability Standards

• CBDCs must be designed to be interoperable with existing domestic payment systems and international CBDC frameworks.
• India can play a leadership role in aligning its CBDC with the G20’s roadmap on cross-border payments, which emphasizes global interoperability standards.

Developing a Transparent Legal and Regulatory Framework

• A clear and robust legal framework is necessary to address issues related to liability, taxation, and consumer protection in CBDC transactions.
• Global standards, such as the “CBDC Design Principles” by the World Bank or the BIS, can serve as benchmarks for regulatory policies.
• The provisions of India’s Personal Data Protection Act 2023 should be incorporated into the CBDC framework to ensure data privacy and protection.

Leveraging Public-Private Partnerships (PPPs)

• Engaging private players in CBDC development can drive innovation and reduce implementation costs.
• Fin tech companies can assist in designing user-friendly applications and payment solutions, while block chain start ups can enhance security and efficiency.
• Public-Private Partnerships (PPPs) can ensure scalability, keeping implementation aligned with market demands and technological advancements.

The End of the Blog- Scope for Central Bank Digital Currency in India