India’s central bank buys into digital

However, the precise contours or the version of the CBDC that the RBI will adopt are not yet known. Central banks are contemplating two variants – wholesale and retail. The wholesale variant restricts the availability of the CBDC to financial institutions who hold reserves at the central bank. The underlying objective is to enhance the efficiency of payments and settlement systems.

In the retail variant, the CBDC is issued to the public who can then use it as a means of payment, investment or deposits. The advantage of a retail version is it will lower transaction costs for the public to the extent that it obviates for the need for banks to intermediate. It will, however, require CBDC holders to have accounts with the central bank in a centralised manner.

The retail version may entice greater attention among emerging market central banks as it is posited to promote financial inclusion and reduce cash printing and handling costs.

What’s the difference?

The key difference between the e-Rupee and a cryptocurrency is that, akin to a paper currency, the former will have the full backing of the RBI. In other words, it will be a liability of the RBI. What it also means is the value of the e-Rupee will be dictated by the same set of macro variables (growth, monetary and fiscal policy, foreign exchange reserves etc) as a physical rupee.

In contrast, the issuance of cryptocurrencies is decentralised, devoid of any central bank involvement. Cryptocurrencies have their own unit of account with no policy anchor behind their issuance. Their issuance is based on pre-set rules and their value is guided by demand and supply. For example, the supply of Bitcoin, which is arguably the most popular cryptocurrency, is fixed at 21 million bitcoins. Of these, roughly 19 million have been already mined.

Because of this, the value of cryptocurrencies is inherently volatile and their adoption as a mode of payment has been slow at under 1 per cent of total global payments. Another growing concern is the illicit use of cryptos. Although the share of illicit transactions in total volume is low, there is always a risk of it growing quite rapidly.

As such, cryptocurrencies have largely evolved into instruments for speculation and, akin to gold, have gained in value when central banks in advanced economies had embarked on quantitative easing. These features, unlike for CBDCs, make cryptocurrencies appear more like an extremely volatile financial asset than a medium of exchange

That said, a new variant of cryptocurrencies - known as stablecoins - whose value is linked to an external anchor like gold or the dollar has also emerged. Stablecoins offer the benefit of a private currency as well as the lowere volatility valuation of a fiat currency. In this sense, they are a bridge between conventional currencies and cryptos and it is conceivable their popularity in payments will rise.

In fact, trading volumes in stablecoins has been accelerating and their market capitalisation in the overall crypto universe doubled from 2-3 per cent in the pre-pandemic period to 6 per cent at the end of December 2021.

Economic advantages for India

While there is no universal definition of financial inclusion, it broadly alludes to access to useful and affordable financial products including loans and deposits and is viewed as critical in alleviating poverty and income inequality.

There has been tremendous improvement in financial inclusion in India in recent times with the share of adults having bank accounts rising from 53 per cent in 2014 to 80 per cent in 2017. This is well ahead of other Asian economies with similar per capita incomes, such as Indonesia, the Philippines and Thailand. Even so, a large absolute number of people are still being excluded.

Moreover, the quality and availability of banking services is disparate, especially with large swathes of the rural population still having to rely on cash or informal-sector borrowings for a variety of transactions, including mortgages. The RBI’s own annual financial inclusion index for India corroborates this.

The ‘quality’ sub-index shows the regional disparity in credit outstanding was most prominent with the Gini coefficient at 0.72 in 2021 (Gini value of 1 means complete inequality), followed by disparity in the deposit amount with the Gini coefficient of 0.58. It is possible this problem of under-banking and disparity in availability of quality financial services will ease under a retail CBDC model.

One of the other key benefits of CBDCs is an improvement in the targeted disbursement of social benefits, including subsidies. With CBDCs, not only can the reach of social benefits be extended to a larger number of beneficiaries but it can also be ensured the subsidy is available for specific purposes only, minimising leakages. For example, a pre-programmed CBDC can be issued specifically for purchasing cooking gas to low-income households. This type of CBDC will be accepted only at a cooking gas selling outlet who can then exchange it into a general purpose CBDC. The same goes for food or fertiliser subsidies.

This is a key positive aspect in the Indian context, where subsidy leakage or diversion of subsidy resources to unintended purposes is a huge policy concern. For example, India spends roughly 2 per cent of gross domestic product on energy subsidies, such as for kerosene and cooking fuel, where the leakages are to the tune of 10-40 per cent.

A ‘no-CBDC’ scenario

While cryptocurrencies in their current avatar may not deliver the benefits possible with CBDCs, it is a growing possibility they may evolve into a high-volume payment mechanism over time.

Stablecoins have been a remarkable addition to the crypto universe. Their prominence will undermine the central bank’s monopoly over currency issuance and management, a phenomenon that will in theory be akin to currency substitution or dollarisation of the economy. In such an event, it will impair the RBI’s ability to manage inflation and affect counter-cyclical policies.

Even if crypto currencies are not used for payments, they can become a ‘store of value’ in periods of economic and financial stress. For instance, there have been anecdotal reports of a surge in the use of cryptocurrencies in Turkey during the recent episode of surging inflation and depreciating Lira.

Central banks are aware of this growing threat. India’s government, along with some others like Malaysia and Thailand, has made payments through cryptocurrencies illegal - although it is not clear how this can be monitored given anonymity in their usage. Additionally, the RBI has imposed a 30 per cent capital gains tax on crypto transactions.

To be sure, even though the e-Rupee may not be able to fully resolve these issues as its character will skew towards ‘medium of exchange’, it can help mitigate them to some extent.

On the surface, while it may appear there will be negligible impact from the digital rupee as it will merely replace the conventional rupee, the nuances are more involved. There could be both positive and negative ramifications of this transition.

On the positive side, especially under a retail CBDC model, monetary policy transmission will likely improve and be much less lagged. Banking sector competition and market efficiency will improve, lowering the cost for good borrowers.

On the negative side, there could be significant adjustment costs for the banking sector, which may see a relegation of their role as financial intermediaries. A fall in deposits could mean a decline in the credit multiplier, warranting liquidity infusion by the central bank. 

Although the variant of the e-Rupee, the underlying technology (blockchain or another) and the operational parameters are far from crystallised, its advent seems inevitable. The competition from decentralised currencies will simply become too big to ignore.

ANZ Research sees several benefits of a retail e-Rupee including improving access and quality of financial services, enhancing fiscal transfers and potentially improving policy transmission. At the same time, the role of India’s banks will need to be redefined. The RBI Act, 1934 will also need to be modified if the RBI were to adopt the retail e-Rupee model and accept deposits from the public.

Given the ‘unknowns’ at this juncture, ANZ Research’s views will be updated as progress is seen from the RBI on this front.

Sanjay Mathur is Chief Economist Southeast Asia & India and Dhiraj Nim is Economist & FX Strategist at ANZ