With the central bank poised to begin the process of adopting an official digital currency, veteran finance adviser Shivanand Pandit assesses the checks and balances needed to safeguard the process

The lawfulness of cryptocurrencies in India remains murky, but the Reserve Bank of India (RBI) is working on a “phased implementation strategy” for a Central Bank Digital Currency (CBDC). Four years after an inter-ministerial committee’s recommendation to launch fiat money in the digital format, the RBI has signalled that preliminary plans to discover its feasibility are likely to be launched soon.

The deputy governor of the central bank, Rabi Sankar, has mentioned that the RBI is working towards a phased execution plan for its own digital currency, and is in the process of introducing it in the wholesale and retail sectors shortly. He said that central banks have enhanced their care on digital currencies, and their launch will be supported by the sovereign, which will assist in reducing the use of cash in the economy and reduce risks to the public from the use of private currencies.

Sankar also said the RBI is scrutinising uses with little or no disruption to India’s banking and fiscal systems. He has cited that legal modifications would be essential, as contemporary provisions had been made with regard to currency in a physical shape under the Reserve Bank of India Act. He said significant amendments would also be needed within the Coinage Act, the Foreign Exchange Management Act (FEMA), and the Information Technology Act.

Sankar said that cryptocurrencies such as Bitcoin certainly did not match the RBI’s definition of “currency”. This was the main reason that the RBI, together with other central banks all over the world, are considering CBDCs as a substitute to the volatile crypto asset in the conventional economy, as the CBDC curtails damages and is not subject to the volatility of market instabilities.

Identifying risks

In 2017, a high-level inter-ministerial committee was established by the Ministry of Finance to examine virtual currency matters and recommend a plan of action. The committee’s 2019 report focused on numerous risks linked with private parties and decentralised virtual currencies, comprising value fluctuation risks, absences of regulation, technology-related risks – namely phishing and Ponzi schemes – illegal and criminal uses such as terror funding and money laundering, and the stress on a nation’s energy resources due to scarcity and processing demands.

The committee report suggested rolling out a CBDC, as well as the criminalisation of incidents surrounding cryptocurrencies. The creation of a statute prohibiting proposed cryptocurrencies is also in this committee report.

The government’s opinion has consistently been that a digital currency in India would only be accepted if issued and controlled by the sovereign. A CBDC is envisioned to be a form of digital currency issued by the RBI and approved by the central government as legal tender. It is presumed that it will be secure, effective and hold persistent value, rather than erratic changes in value like the private cryptocurrencies.

A CBDC is fundamentally legal tender issued by the central bank of a country. It has similar functional abilities to a fiat currency, and is considered transferable in nature with said fiat currency in a one-to-one form. The only key difference is the digital form it takes. Private crypto assets such as Bitcoin and Ethereum have no legal issuers and cannot be judged as money or currency, whereas the CBDC can be considered money or currency.

The CBDC is the equivalent of any other currency issued by a central bank – an independent currency issued but in electronic shape and this type of currency reflects as a currency in circulation on the central bank’s balance sheet.

India needs a digital rupee

The substantial upsurge of private cryptocurrencies has spooked central banks around the world and pushed the case for official digital currencies. Many chief central banks have started experimenting with a digital currency. The Eastern Caribbean Islands – which share a central bank – including Grenada and St Kitts and Nevis, have already launched their own versions. The US Federal Reserve and the Bank of England are looking into the possibilities, while China, having already been involved in trial missions for digital renminbi, is in fact planning a major roll-out soon. According to a study by the Bank of International Settlements (BIS), 86% of central banks throughout the world are examining and researching CBDCs, 60% are presently experimenting with it, and 14% of central banks are in the initial testing stages with CBDCs.

There is little doubt that India wants a digital rupee. A CBDC can make all four functions of central banks in the payment segment more efficient. These four tasks are providing means of payment, providing finality of payment, providing liquidity to guarantee effortless settlement, and providing systematic integrity and efficiency.

The launching of a CBDC will drastically reduce the cost of printing, transporting and storing paper currency. Executing with a CBDC would be an immediate procedure and the need for interbank settlement would vanish as it would be the central bank accountability handed over from one person to another. By adopting a CBDC, foreign trade transactions could also be accelerated between nations.

A CBDC could permit an economical and more real-time globalisation of payment methods. It allows an Indian exporter to pay dues on a real-time basis without any intermediary. Moreover, the hurdles of dollar-rupee transactions, the time zone difference in such transactions, would almost evaporate.

Walk the talk carefully

Although the clarity surrounding the introduction of a digital currency given by the RBI is welcome, the much-awaited Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, is yet to be introduced. The central bank needs to frame vital decisions about the sketch of the currency, relating to how it will be issued, the degree of secrecy it will have, the type of technology that is to be used, and so on.

While the RBI is evaluating whether the digital currency should be at the retail or wholesale level of gross settlement, the CBDC should be available for both wholesale and retail payments. This will make a real difference. Even though China has suggested a hybrid model, the crucial issue for the RBI is whether the digital currency should be account-based or tokenised.

The decision about the scale of secrecy is also quite a challenging one. Some level of secrecy can be built into the blockchain-centred pattern that recognises transaction records. A CBDC could check private payment system providers from dominating transaction data through a self-reinforcing loop of data, network externalities and activities, attracting ever more users.

The RBI should carefully consider all probable influences of an official digital currency on people, the monetary policy and the system of banking. There are other major perils to be taken into account as well, including those evolving from cybercrimes. More importantly, many laws need to be amended to make the digital rupee a reality.

The RBI should also consider other issues, such as whether CBDCs should be issued through a distributed ledger synchronised between the RBI and scheduled banks, or a centralised ledger held by the RBI. Should each CBDC be validated and identified by a unique serial number or token, or how else would validation be done? Should distribution be only through the RBI, or via banks? And how will authorities account for CBDCs in the money supply?

A CBDC may put stress on traditional banking by lessening the volume of deposits. It may not be an interest-bearing instrument, since physical notes are not, and can have inferences for commercial banking. Bank credit is backed by the volume of deposits, and if a CBDC catches on many people may shift away from deposits. This will decrease the availability of cash for bank credit, compressing net interest margins, which may influence investment and growth.

There is also a likelihood that, given CBDCs would permit immediate withdrawal, it could cause depositors to immediately do so in case there are reports of a struggling bank. The RBI should tactfully handle such occurrences.

As a final point, India has done remarkably well in digital payments in recent years. Interestingly, they have grown at a compounded annual rate of 55% in the past five years. Nonetheless, the digital rupee will be something else completely.

Setting up a digital currency will need cautious calibration and a proficient approach in execution. Drawing board discussions and stakeholder consultations are significant. Notwithstanding all the obstacles inherent in the process of launching the digital rupee, the answer to the title of the deputy governor’s speech – Central Bank Digital Currency: Is this the future of money? – is a definite yes.


Shivanand Pandit is an independent finance and tax adviser with 25 years of experience in the fields of finance, accounting, taxation laws, wealth management, audit, corporate and banking laws. He can be reached at: panditgoa@gmail.com