CBDC and India: What Does the Future Hold?

The Union Budget 2022 brought a new buzzword to light for the Indian citizens: CBDC. For many, CBDC is a synonym for the much-hyped cryptocurrencies but the actual meaning seems to be quite different. So, if CBDC is not a cryptocurrency, then what is it actually?

The Central Bank Digital Currency or CBDC, as it is widely known, refers to the digital form of a country’s fiat currency. Since the fiat currency of a country is issued by the central bank of the country, CBDC also enjoys the backing of the central bank. This backing makes CBDC a legal tender for transactions such as paying household bills or buying goods and services.

But isn’t this something that we are already doing? India does not officially have a CBDC yet but we can still transfer money digitally from our account to someone else’s account at a different bank, right? However, with a CBDC, such transactions would not need to pass through multiple banks. It would all happen instantaneously, as if you were exchanging cash with someone in real-time. The presence of a CBDC in an economy would also eliminate the mandatory need of having a commercial bank account to make digital transactions. Therefore, CBDCs would pave a path to make digital payments even for those who are unbanked.

CBDC & Cryptocurrencies: Where Lies the Difference?

Cryptocurrencies like Bitcoin, Ethereum, Dogecoin and many others are independent digital currencies that do not have any predetermined value and are not backed by any central authority. Therefore, the value of cryptocurrencies is a sheer matter of demand and supply. In contrast to this, the CBDCs are issued and regulated by the central bank of a country and can be defined as a counteract move intended to eliminate the inconstancy and unaccountability that the cryptocurrencies possess.

The rapid rise in circulation of cryptocurrencies is one of the major reasons for many countries to explore the potential of their own, much stable digital currencies. Before India, many other countries like China, the Bahamas, Sweden and the European Union have embarked on the journey to mull CBDCs of their own.

CBDC and its Relevance in India

Currently, India is leading the world in terms of the dramatic innovations that are taking place in the digital payment space. According to the Reserve Bank of India, the use of

physical cash in transactions too has been on the decline in recent years, a trend further reinforced by the ongoing Covid19 pandemic. This deviation from the traditional fiat money to electronic and private money has given rise to a plethora of opportunities. For central banks, introducing a CBDC in the economy would be a measure to meet the public’s need for digital currencies and combat the damaging consequences of private currencies. Today, most security clearing and settlement processes face a multi-day lag. With a CBDC in place, the payments made would be final and there would be a significant reduction in the settlement risk in the financial system.

As per the RBI website, “CBDCs would also potentially enable a more real-time and cost-effective globalization of payment systems. It is conceivable for an Indian importer to pay its American exporter on a real time basis in digital Dollars, without the need of an intermediary. This transaction would be final, as if cash dollars are handed over, and would not even require that the US Federal Reserve system is open for settlement. Time zone difference would no longer matter in currency settlements — there would be no ‘Herstatt’ risk.”

Furthermore, the RBI believes that the cost of issuing and distributing digital currency would be significantly less in comparison to the printing and distribution cost of hard cash. The influx of Indian CBDC, Digital Rupee, shall also assist the government in the quick transfer of public funds during unforeseeable crises. Since all the CBDC transactions would be recorded on a digital ledger, tracking of money would be much easier and cheaper.

Being in the early phases, CBDCs appear to be a paradigm shift towards an economy where physical money is no more dominant. However, the success of CBDCs in India or anywhere else in the world is reliant on the way it is implemented and integrated with the current financial system.