Explained: CBDC, the ‘Digital Rupee’ that RBI Could Introduce this Year - UPSC Current Affairs

Digital Rupee upsc

Today’s edition of our Current Affairs will comprise a discussion on CBDC, the ‘Digital Rupee’ that RBI Could Introduce this Year. Read further to upgrade your UPSC CSE knowledge and also understand the topic’s relevance to the UPSC syllabus.

For Prelims: CBDC, RBI, Cryptocurrency, Bitcoins 

For Mains: Central Bank Digital Currency, Fiat Money, Legal Tender, Digital Rupee 

Probable Question

Recently, RBI proposed introduction of India’s digital currency or Central Bank Digital Currency (CBDC). What are the challenges and opportunities of introducing CBDCs parallel to paper currency?

Context

The Reserve Bank of India (RBI) is planning to launch India’s digital rupee, named the Central Bank Digital Currency (CBDC). It can be introduced in phases beginning with wholesale businesses in the current financial year 2022-23.

About Central Bank Digital Currency (CBDC)

  • CBDC is the legal tender issued by a central bank in a digital form. 
  • Its value would be the same as a paper currency and is exchangeable one-to-one with the fiat currency. 
  • In short, a CBDC is no different from the cash that we hold in our wallets, except that it exists in a digital form. 
  • The digital fiat currency or CBDC can be transacted using wallets backed by blockchain.
  • Although the concept of CBDCs was directly inspired by Bitcoin, still, it is different from decentralized virtual currencies and crypto assets, which are neither issued by the state nor have the ‘legal tender’ status. 

Amendments to the Reserve Bank of India Act, 1934

  • To introduce digital currency as CBDC, there is need of amendments to the TBI 1934 Act, which would enable it to launch a CBDC. 
  • The proposed amendments would be to enhance the scope of the definition of ‘bank note’ to include currency in digital form. 
  • Currently, RBI has been examining use cases and working out a phased implementation strategy for the introduction of CBDC with little or no disruption.
  • The government had also been planning, to introduce a Bill in Parliament to prohibit all private cryptocurrencies with certain exceptions, as they increase concerns over money laundering, terror financing, tax evasion, etc with private cryptocurrencies like Bitcoin, Ether, etc. 

Reasons for Issuing Digital Currencies

  • RBI has constantly opposed private digital currencies and had proposed the government widen the scope of the paper rupee to include currency in a digital form.
  • The increasing demand for digital currencies, the rise of private digital currencies such as bitcoin, and the increasing use of digital payments as examples of this secular trend are some factors for issuing digital currencies.
  • Moreover the Central bank digital currencies are more reliable and sovereign-backed alternatives to private currencies which are volatile and unregulated. 
  • The cost of issuing digital currencies is far lower than the cost of printing and distributing physical cash as everything happens in digital currencies electronically. 
  • The introduction of digital cash may bring down the use of physical cash, which is hard to trace, whereas a digital currency that is monitored by the RBI can be more easily tracked and controlled. 

Read yesterday’s edition of current affairs on Saksham Anganwadi and Poshan 2.0,in case you missed reading it.

Is CBDC Becoming Common Across the World?

  • Countries like the United States, the European Union, and China, have been working seriously towards issuing their own Central Bank Digital Currency (CBDC) in recent years. 
  • In October 2020, the Bahamas launched the world’s first CBDC. 
  • In a 2017 note, Denmark’s central bank indicated that it was “unclear what central bank digital currency would be able to contribute that is not already covered by the current payment solutions.”
  • Some countries like Denmark are unclear about issuing the digital currency and doubt the potential benefits of introducing CBDC, along with the challenges that this introduction would present.

Related Article: Rupee Rouble Mechanism 

Significance of Central Bank Digital Currency (CBDC)

  • It will reduce the dependency on cash or paper rupee.
  • Seigniorage, which is basically the gap between the value of money and the production and distribution cost, would be higher due to lower transaction costs.
  • It will also reduce settlement risk. 
  • It would also lead to a more robust, efficient, trusted, regulated, and legal tender-based payments option.
  • In CBDC, there is no need for any third party or a bank, to conduct both domestic and cross-border transactions.
  • In addition, a digital rupee transaction would be instantaneous as opposed to the current digital payment experience.
  • Introducing its own CBDC has been seen as a way to bridge the advantages and risks of digital currency.

Related Article: RBI monetary policy upsc

Risks in Adopting Digital Currencies Issued by Central Banks

  • Currently people use their bank accounts majorly for safely storing their cash, but through CBDC people could very well begin converting their bank deposits into digital cash.
  • In countries like India, where bank accounts offer positive returns, could prevent any large amount of conversion into digital cash. But in developed economies, where interest rates are near zero or even negative, the risk of people rushing their money out of bank accounts and into digital currencies is real. 
  • The banks will be able to create fewer loans, in case customers convert their bank money into CBDCs, that would force the banks to surrender at least some cash and thus the bank would possess an even smaller base to create loans. 
  • Also, the RBI would be required to ultimately take these liabilities from banks, when bank customers convert their deposits into digital rupee.
  • One of the primary reasons for people to switch to private digital currencies is privacy. The feature in CBDC that will enable monitoring, tracking, and controlling raises concerns regarding privacy and could slow down their adoption.

Way forward

  • There is speculation already that Central banks will cap the amount of money that an individual can hold in the form of CBDCs, to prevent the mass withdrawal of deposits from banks. 
  • Some Central banks, such as the European Central Bank, may impose a negative penalty on their digital currencies, to force people to spend their digital currencies and to discourage the withdrawal of deposits from banks.
  • To ensure that the ability of banks to create loans is not affected by depositors’ rush to digital currencies, the Central banks may also have to provide more fresh money.

News Source The Indian Express, The Hindu

https://indianexpress.com/article/explained/explained-economics/cbdc-the-digital-rupee-that-rbi-could-introduce-this-year-8105208/

https://www.thehindu.com/business/Economy/rbis-digital-currency-plans/article38395561.ece#:~:text=A%20CBDC%20is%20no%20different,delegate%20some%20power%20to%20banks.

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