Central Bank Digital Currency: The Indian Perspective

Author: Mr. Sourav Padhi

The author is an alumnus of National Law University Odisha. He is presently working as an in-house legal counsel.


I. Introduction

The payment landscape across the globe has been transformed over the last decade with the integration of technology and digitisation in the financial sector. Digital innovation in finance has led to the introduction of digital products which have stepped up the demand for an easier, faster, and cost-efficient global payments system. Central Bank Digital Currency (“CBDC”) is also a similar product that is expected to revolutionise the way people transact on a day-to-day basis. The RBI deputy governor T. Rabishankar has defined it as “a 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.

The Bank of International Settlement (“BIS”) surveyed several central banks in 2021. It was found that 86% were looking into the potential of CBDCs, 60% were trying out the technology, and 14% were running pilot projects. Central Banks and Monetary Authorities across the globe including the USA, Canada, Singapore, and the Bahamas, have started exploring different ways and forms of CBDC which can be launched within the existing regulatory and economic framework. China has launched its digital Yuan on a pilot basis in four pilot provinces since May 2020 with an objective for a nationwide launch in a phased manner.

II. What is CBDC?

Among some of the critical features of CBDC is that it shall be issued and backed by the central monetary authority to make it a valid legal tender. CBDC designs shall be acceptable and adaptable for any application, and they would also be linked to the fiat currency. It would reduce the cost for central banks to issue paper currency and reduce the risks associated with cash handling, apart from helping to develop a more efficient and effective settlement system. It would also facilitate the development of a digital economy and a resilient payment system while promoting financial inclusion and building of a cost-effective cross-border and domestic remittance system. CBDC would reduce the popularity and usage of private currency like cryptocurrency which does not have the backing of any central bank or monetary authority.

In developing countries with low banking penetration, it would help to promote financial inclusivity. CBDCs can grant users access to government-backed payment systems even without bank accounts, using only a mobile phone and internet connection.

The BIS recognises that the function of the central bank and the private sector in maintaining a digital ledger for recording transactions is a crucial component of the CBDC design. The central bank can either manage the core infrastructure supporting record-keeping and related tasks itself or delegate these responsibilities to CBDC intermediaries. Both these approaches must consider prudential risk management, data governance, security-risk mitigation, and the effect on competition in India’s payments market.

III. The Indian Scenario

The Reserve Bank of India Act, 1934 (“RBI Act, 1934”) empowers the Reserve Bank of India (“RBI”) to “regulate the issue of bank notes and the keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage.” Recently the Finance Bill, 2022 has proposed requisite amendments in the RBI Act,1934 inter-alia inclusion of ‘digital currencies’ in the definition of ‘bank note’. The amendment would enable RBI to issue digital currency in addition to the physical currency notes. In its annual report for 2021-22, the RBI also proposed a graded approach to CBDC implementation, i.e. going through stages of pilot, in accordance with the objectives of monetary policy, financial stability, and efficient operations of currency & payment systems.

RBI’s proposed design could be based on one of the unilateral, intermediated or synthetic models recognised by the International Monetary Fund (“IMF”). The design should be resilient to any operational disruptions and natural disasters, along with being accessible for offline transactions on a 24/7 basis without any barriers to use. The architecture and the technology employed for CBDC should be flexible enough to allow the system to respond to changes in the volume and the value of transactions throughout its lifecycle. Its security standards should protect not only the CBDC system but also the users from security breaches, cyber-attack or any attempt of counterfeiting. So, the design should allow interoperability allowing payments between users of CBDC with other payment service providers and deposit accounts. It should also enable tiered models which shall have a retail and wholesale model, to permit CBDC Intermediaries to innovate and develop additional services on the CBDC platform and support innovative use that can meet the changing payment needs and behaviour of users.

IV. Factors Determining Implementation in India

While implementing a CBDC framework, the RBI will need to make several design choices. These decisions will largely determine the ramifications for India’s digital payments ecosystem. RBI will also have to consider appropriate amendments to the existing digital payment legislations and regulations for accommodating the digital rupee. Additional factors like internet density, financial literacy, and smartphone penetration would influence the Indian CBDC technology. RBI has to factor in all the implementation risks and challenges before launching the digital rupee in the economy.