Come December and the Reserve Bank of India (RBI) could be rolling out a pilot for India’s very own digital currency, an innovation that is tipped to change how currency is held and used in the time to come. To be sure, the idea is not to replace physical money, or replicate cryptocurrencies. Known as central bank digital currencies (CBDCs), these will, in fact, be much like the current system, although the underlying structure, founded on cash usage so far, would undergo a revolutionary change.
“A CBDC is the legal tender issued by a central bank in a digital form. It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different," RBI Deputy Governor T Rabi Sankar said in July this year. The advantage that a CBDC offers is greater efficiency and flexibility, allowing for better oversight and more seamless transactions.
“CBDC is the same as currency issued by a central bank but takes a different form than paper. It is the sovereign currency in an electronic form and it would appear as a liability on a central bank’s balance sheet. The underlying technology, form and use of a CBDC can be moulded for specific requirements. CBDCs should be exchangeable at par with cash," Sankar added.
James Pomeroy, Global Economist at banking and financial services major HSBC, says that CBDCs could “replace cash and transform the banking system globally within a generation. The benefits could include increased growth and reduced poverty in the emerging world".
In fact, one trigger for central banks across the world hurrying up with their planning and exploration of digital
currencies have been the Covid-19 pandemic and the increased usage of digital payments has fostered as lockdowns kicked in and customers moved online for most purchases. Thus, coming up with a digital currency is a way for central banks and economies to keep up with the times.
“Use of physical cash in transactions, too, has been on the decline in recent years, a trend further reinforced by the ongoing Covid-19 pandemic. These developments have resulted in many central banks and governments stepping up efforts towards exploring a digital version of fiat currency," said RBI Deputy Governor Sankar, adding that a “driver" behind rolling out CBDCs “is to provide the public with virtual currencies, that carry the legitimate benefits of private virtual currencies while avoiding the damaging social and economic consequences of private currencies”.
Evidently, a CBDC would work in much the same way as a digital wallet works now. But instead of physical cash, a bank would only issue a digital version. Cash economies require that banks be able to provide physical notes to the equivalent of the money deposited with them by customers. However, with digital currencies, instead of printing cash, the central bank will issue fixed supplies of digital monies that will be received and spent electronically. It will lead to lower spending on printing, storing and distributing banknotes and, hence, also represents an environmental benefit in the time of climate crisis.
But there will be other real-world benefits, too. Sankar says that “payments using CBDCs are final and thus reduce settlement risk in the financial system". The idea is that when a CBDC is transacted instead of the bank “the need for interbank settlement disappears".
Further, in an increasingly globalising world, it is in the area of international transactions that CBDCs can be of significant help, enabling “a more real-time and cost-effective globalisation of payment systems". Sankar says that a CBDC would make it “conceivable for an Indian importer to pay its American exporter on a real-time basis in digital dollars, without the need of an intermediary". Such a transaction “would be final" and not even require that “the US Federal Reserve system is open for settlement", thus making time zone difference in currency settlements redundant.
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