Considering the Possibility of a Central Bank Digital Currency in India

Earlier this year, the Indian Supreme Court overturned the central bank's decision to ban cryptocurrency in the country. The Reserve Bank of India (RBI) continues to be averse to accepting crypto-assets and private digital currency. However, there is one idea that seems to be gaining ground in terms of digital money: introducing a central-bank digital currency (CBDC).

Last year, the RBI had hinted that it was exploring the issuance of CBDC, which is a cryptocurrency or a digital payment token issued by the central bank of a country and can take either a retail or wholesale form. Wholesale CBDCs can be used by financial institutions holding reserve deposits with the central bank, while private individuals and corporations can use retail CBDCs.

The Indian central bank is not alone in considering the possibility of introducing CBDC, as many countries are considering this and a few have even partially implemented such digital currencies. For instance, the French government has launched an experimental programme to test the integration of CBDC to ease inter-bank settlements.

The Indian central bank's plan to introduce such a currency would be a welcome move—especially at a time when the Government is encouraging and incentivizing the development of fintech. Not only has the RBI introduced a myriad of guidelines intended to assist digital payments, but it has even set up a regulatory sandbox for fintech innovation.

Further, the National Payments Corporation of India (NPCI) has adopted a blockchain-based system, called 'Vajra', based on distributed ledger technology (DLT), to deal with automated payment clearing and settlement processes. This system, useful in providing highly secure and tamper-evident transactions stored in a distributed and immutable database, demonstrates the Government's willingness to implement technologies to support the introduction of digital currency.

Another reason to introduce CBDC is its potential to overcome obstacles in creating a retail system, as envisioned by the RBI. In August 2020, the RBI had announced a framework for the establishment of a new umbrella entity that would set up and operate new payment systems in the retail space. The concept of retail CBDCs could significantly advance the objective.

Private individuals and households could use such retail CBDCs without having to approach traditional banks, reducing time and cost. Such currencies would also allow financial institutions to settle with the central bank instantaneously directly, reducing credit and liquidity risks. The digital nature of CBDC would facilitate lending at every level. Overall, the introduction of the currency is likely to improve the efficacy of monetary policy.

However, a robust regulatory framework with appropriate guidelines would need to be in place before their operation. As CBDC has not been implemented by any country yet, the RBI would have to start from scratch. What is of interest is that to make the system operationally effective, the RBI would have to create and develop an entirely separate set of regulations, even though such currency would not alter the fundamental mechanics of existing monetary policy.

As the technology has not yet fully evolved, and the digital form of the Indian rupee continues to be in its nascent stages, a conclusive policy is yet to take shape. There are many aspects that the RBI will have to deliberate: for instance, whether to introduce an account-based or token-based system, whether to adopt a wholesale/retail distinction or a general-purpose currency, and whether to implement centralized or decentralized governance of CBDCs, among other things.

Implementing the new technology would also require extensive training within financial institutions, as well as building a comprehensive and robust technological infrastructure to support CBDC. It is expected that if CBDC were introduced, the RBI would implement monetary policies and hold the accounts the same way it does currently. Fintech companies would be given the  option to manage client relationships and to be the channel for retail transmission. 

The governor of the central bank has made it evident that the RBI remains strongly opposed to private digital currencies, asserting that they could interfere with essentially a sovereign function. The inclusion of CBDC would, therefore, be in furtherance of its position. Centralization and government regulation would distinguish a CBDC from cryptocurrency. Unlike cryptocurrencies—which function through numerous distributed nodes—CBDCs will be maintained by a central network that will further the public policy of the State.

As such a currency system would entail an alternative payment mechanism that is controlled and regulated by the central bank, it could help in mitigating counterfeiting and tax evasion. Unlike cryptocurrency, this system can be a tool to advance the central bank's policies and agendas.

Last year, the RBI governor said that the technology had not matured enough for the bank to start considering it seriously. However, given the RBI's marked shift to digital payments, the Supreme Court's affirmation of cryptocurrency and the fast-evolving CDBC technology,  as well as the need to go 'cashless' because of the pandemic, experts are expecting a change in the RBI's attitude.

Although it may not be immediate, the Indian government would have to start evaluating the advantages of such a digital currency soon, mainly to keep up with other central banks that are opting for the digital currency.

Dr Poornima Advani is the Managing Partner of The Law Point (TLP), a full-service Indian law firm. She currently also serves as an Independent Director of one of India’s largest sustainable energy companies; and formerly served as the Chairperson of National Commission for Women (India).