By Rohanshi Vaid, Shubhangi Gupta, Ammu George
The Reserve Bank of India (RBI) recently kickstarted its digital rupee (e₹) pilot program, preceded by the Concept Note of October 7, 2022, which explained the objectives, mechanisms, and motivations of floating the digital currency in the country. More importantly, it explores the implications of the induction of a CBDC on the monetary policy, financial stability, and banking system of the Indian economy.
Prepared with laudable swiftness, the Note is balancing on a tightrope between lucidity and ambiguity, and at times tips over to the latter side. Some aspects of the Note need further thought and clarity for a comprehensive understanding of CBDC issuance in the country.
Why Digital Rupee now?
Unlike other countries with relative merits of CBDCs suited to their economies, the case for a CBDC remains unclear in India’s context. For example, the Bahamas and the Caribbean have floated the CBDCs to counter cash disbursement issues owing to their tough geographical terrain. The Swedish Central Bank is exploring the rollout of a digital currency to address the dwindling usage of cash in its economy. India, on the other hand, does not seem to have a pressing need for an immediate CBDC rollout. The digital payments industry has witnessed remarkable growth, thanks to the innovation of the Unified payments Interface (UPI) and pandemic-induced shift in preferences. While India still reaps the benefits of UPI as it reaches the nooks and corners of the country, a larger question on the need for a sudden embrace of the digital rupee arises.
The challenge of financial illiteracy remains The Note specifies financial inclusion as one of the main motivations. Taking stock of the existing challenges to financial inclusion, the Note postulates that “[e₹] shall make financial services more accessible to the unbanked and underbanked population”, especially with the offline functionality. While solutions to limited physical infrastructure are well received, the purpose will remain unfulfilled and financial illiteracy continues to be a challenge for large parts of the country. It seems excessive to allude that marginal groups, especially in rural areas, who are unfamiliar with the traditional banking system can immediately switch over to a digital rupee despite its close resemblance to cash.
The question of anonymity The decision to design the CBDC as close to cash as possible gives rise to an inescapable dilemma –
ensuring anonymity while making the payments secure. For retail consumers, the funds recoverability in case of a system breach would depend on the degree of robustness of security protocols from the Token Service Providers (TSP). The more robust the protocols, the lower the degree of anonymity. This leaves retail users and their data at the mercy of private TSPs. While the Note does indeed consider providing some degree of anonymity to smaller transactions, the threshold is not clearly defined.
Further, the case of anonymity weakens for the CBDC when TSPs implement KYC (for customer verification), which has been hailed by the IMF as essential to digital currency rollout. India’s national ID scheme Aadhaar seems to be a strong contender here. It seems surprising that the note did not mention the prospects of using the world’s largest biometric system as a substitute for the KYC.
Need for an overarching legal framework Addressing the criticality of consumer protection for effective deployment of CBDC, the Note emphasises strong cybersecurity, technical stability and resilience, and sound technical governance. What it misses is that many economies in the pilot phase of the CBDC implementation have data protection laws in place. Canada’s existing Personal Information Protection and Electronics Documents Act (PIPEDA) and an upcoming improved Consumer Privacy Protection Act (CPPA) to China’s Data Security Law (DSL), Cyber Security Law (CSL), and Personal Information Protection Law (PIPL) together form a comprehensive legal framework to enhance data protection. India, on the other hand, withdrew the much-awaited Personal Data Protection bill earlier this year and does not have a harmonised common privacy law. Currently, the country’s data protection requirements can be found in multiple acts such as the Information Technology Act, 2000 (IT act) and Information Technology (Reasonable Security Practices and Procedures and Sensitive Personal Data or Information) Rules, 2011.
As India’s poor financial literacy could compound the risk of digital payments related frauds, an overarching legal framework that comprehensively addresses data protection needs to precede the CBDC rollout.
High costs of deployment and operations while the note delineates that the operating costs of floating the CBDC are much lower than that of physical cash management, the fixed costs of the former are considerably high. The deployment of sophisticated technology such as quantum resistance only adds to the overall costs of the ecosystem. If RBI proceeds with a token-based CBDC, the operational costs for creating unique tokens would be exorbitantly large. With huge public and private investments already made into the UPI-based digital payments space, additional public investments for CBDC infrastructure could imply a bigger public burden.
The real reason for urgency – keeping up with the world?
The Note also focuses on the importance of cross-border interoperability of the digital rupee for real-time settlements among central banks. Central banks across the world along with Bank for International Settlements (BIS) have collaborated to explore proofs of concept, research applied technologies, and build prototypes. Project Dunbar, for example, launched in 2022, was a collaboration between the BIS and the central banks of Australia, Malaysia, Singapore, and South Africa to explore the viability of a common platform for multiple CBDCs. Many such projects have taken off since 2021 where the participating central banks investigate the functionality and practicality of the CBDCs. Without a CBDC system in place, India cannot partake in such international payment corridors that enable seamless international trade settlements. This may, in fact, be one of the reasons why the central bank, with great fervor, displayed alacrity in floating the digital rupee.
While the embedding of the digital rupee in the international settlement landscape is indispensable and inevitable, a simultaneous focus on it might divert the attention that the domestic CBDC ecosystem deserves at the moment. India is a huge country sustaining multiple sub-national economies comparable to some individual national economies of the world. The country first needs a robust CBDC ecosystem that serves its domestic needs well and then embraces interoperability once enough consumer confidence and adoption are secured. Jumping the gun and bowing to international pressure (G20 commitments) might expose the crevices in the hasty implementation of the digital rupee to vulnerabilities.
The authors are from the Asia Competitiveness Institute, Lee Kuan Yew School of Public Policy, National University of Singapore. Rohanshi Vaid and Shubhangi Gupta are research analysts. Ammu George is a research fellow.