CBDC in India : The Pros and The Cons : Daily Current Affairs

Relevance: GS-3: Indian Economy, mobilization of resources, changes in industrial policy and their effects on industrial growth.

Key Phrases: Central Bank Digital Currency, digital currency, cryptocurrencies, laundering and illicit financing, Sand Dollar, Merits, sovereign, domestic payment, Disintermediating banks.

Why in News?

  • The move to launch a digital currency is a good one, but the government must guard against the risks.

Context:

  • There is an increasing appetite for Central Bank Digital Currency (CBDC) across the world. With private digital currencies — cryptocurrencies — making rapid inroads, threatening the stability of financial system with possible money laundering and illicit financing, governments have to act fast to manage their risks.
  • According to the IMF, around 100 countries are exploring CBDC while some have already been rolled out.
  • Bahamas has been the first economy to launch its nationwide CBDC — Sand Dollar. Nigeria is another country to have rolled out eNaira in 2020.
  • China became the world's first major economy to pilot a digital currency e-CNY in April 2020. Korea, Sweden, Jamaica, and Ukraine are some of the countries to have begun testing its digital currency nd many more may soon follow. European Central Bank and the US Federal Reserve are looking seriously at the issue of CBDC.
  • Any currency, whether physical (paper) or digital should have a sovereign control on its form and volumes that eventually impacts the macroeconomic fundamentals and conduct of monetary policy. Private currency can be as good as credit and cannot be equated with legal tender floated by central banks representing the government.
  • As such, many countries have decided to have their own CBDC to provide more reliable digital currencies to work as legal tender, prompting displacement of private digital currencies.

Merits of CBDC

  • CBDC can provide an easy` means to speed up a reliable sovereign backed domestic payment and settlement system partly replacing paper currency. It could also be used for cross-border payments subject to individual country wise design compatibility, interoperability and legal permissibility.
  • CBDC can gradually bring a cultural shift towards virtual currency by reducing currency handling costs. It can also eventually facilitate cross boarder payments, initially with trading partners who have a two-way dealing to create interoperability as the system integrates.
  • The increased use of CBDC could be explored for many other financial activities to push the informal economy into the formal zone to ensure better tax and regulatory compliance. It can also the pave way for furthering financial inclusion.
  • Since many of the securities traded in the market have been digitised in the last decade, the next in pipeline is CBDC with its inherent merits.
  • Understanding the evolving significance of CBDC, the Union Budget 2022-23 rightly decided to launch a CBDC beginning this fiscal to mitigate the risks and trim costs in handling physical currency, costs of phasing out soiled notes, transportation, insurance and logistics.
  • It will also wean people away from cryptocurrencies as a means for money transfer. However, cryptocurrencies whose value changes on demand and supply can continue to be used by people who have an appetite for speculation.
  • Though RBI has been averse to cryptocurrencies due to the inherent risks, as a developing economy banning such products could indicate shying away from innovations. It could also reflect lack of sturdiness of its risk management systems to cope with cryptocurrencies. Hence, the decision to launch CBDC in India affirms its competence to manage its attendant operational risks.

Risks in CBDC

  • In emerging economies, here are some of the risks of CBDCs:
  • Disintermediating banks: if sufficiently large and broad-based, the shift to CBDC can impinge upon the bank’s ability to plough back funds into credit intermediation. Another possibility is that deposit flight to CBDCs might expand central bank balance sheets posing a question as to how the deposits escaping the banking channel should flow back to the real economy.
  • Low user adoption: This can arise if its usefulness to consumers and merchants are not well perceived. Low CBDC adoption could hinder the policy objectives of the central banks.
  • Elevated cyber security risks, vulnerability testing and costs of protecting the firewalls.
  • Operational burden and costs for the central bank in managing CBDC.
  • Reduced privacy relative to physical cash as the CBDC holdings could be tracked and accounted for.
  • Data privacy threats and compromise of credentials.
  • Faster obsolescence of technology could pose threat to CBDC ecosystem calling for higher costs of upgradation.
  • As the staff have to be retrained and groomed to work in CBDC Operational risks of intermediaries environment.

What Is a Central Bank Digital Currency (CBDC)?

  • Central bank digital currencies are digital tokens, similar to cryptocurrency, issued by a central bank. They are pegged to the value of that country's fiat currency.
  • Many countries are developing CBDCs, and some have even implemented them into their financial systems. Because so many countries are researching ways to transition to digital currencies, it's important to understand what they are and what they mean to society.
  • Features of CBDC:
    • A central bank digital currency is the digital form of a country's fiat currency.
    • A CBDC is issued and regulated by a nation's monetary authority or central bank.
    • CBDCs promote financial inclusion and simplify the implementation of monetary and fiscal policy.
    • As a centralized form of currency, they may not anonymize transactions as some cryptocurrencies do.

Way Forward:

  • In order to obviate some weaknesses of CBDCs, the usage should be payment-focused to improve the payment and settlement system. Then it can steer away from serving as a store of value to avoid the risks of disintermediation and its major monetary policy implications.
  • The RBI should avoid paying interest on the balances so that it remains only as a means of payment and settlement system. BIS has flagged these risks of CBDC.
  • The central banks should build an ecosystem to mitigate them seeking the engagement of all stakeholders. Notwithstanding the initial pain points and risks, CBDC could fast track digital transformation facilitating the move towards a digital economy.

Source: The Hindu BL

Mains Question:

Q. What do you understand by CBDC? Discuss the merit and risks associated with implementation of CBDC. Critically Examine.