With UPI Around, Do We Really Need the Digital Rupee?

Finance Minister Nirmala Sitharaman had recently announced the launch of Digital Rupee – India's version of a CBDC.

Digital Rupee announced.

(Photo: Altered by The Quint)

The reinvention of money, coupled with innovation in payments, is rapidly changing the financial landscape across the globe.

The evolution of money from paper currency to account-based electronic money, and now rapidly proliferating programmable tokenised money, have led central banks to launch CBDCs (Central Bank Digital Currencies) backed by sovereign, representing a new form of central bank money.

Finance Minister Nirmala Sitharaman on Tuesday, 1 February, announced the launch of Digital Rupee – India's version of a CBDC. It will hold the same value as a physical rupee.

Since we already have a robust digital payments infrastructure, do we really need the Digital Rupee? Here are a few reasons why we might.

What Are CBDCs?

The origins of CBDCs can be traced back to the 1980s when Nobel laureate James Tobin, an American economist, proposed that Federal Reserve Banks in the United States could make available to the public a widely accessible medium with the convenience of deposits and the safety of currency.

RBI's Deputy Governor, T Rabi Shankar, described CBDC in his July 2021 speech titled "Central Bank Digital Currency – Is This the Future of Money" as, "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."

Digital Rupee Can Reduce Costs

India has a high currency to GDP ratio. Post demonetisation, cash is back in the economy. The CBDCs can replace large cash usage, and the costs associated with printing and distributing cash can be minimised to a great extent.

Will the Digital Rupee replace cash?

There are no straight answers here. A Digital Rupee is very unlikely to displace the dominance of cash. Unless India's Digital Rupee has privacy and anonymity inbuilt in its design, people won't embrace them wholeheartedly over fears of surveillance.

Wholesale CBDCs Can Boost Efficiency of Financial Systems

Wholesale CBDCs use the existing tier of banking and financial institutions to conduct and settle transactions, similar to traditional central bank reserves. Tokenisation and distributed ledger technology (DLT) can make financial systems efficient and resilient.

Wholesale CBDCs can ensure faster settlement of securities and derivatives. In January this year, phase II of Project Helvetia, a joint initiative by the BIS Innovation Hub, the Swiss National Bank (SNB), and the financial infrastructure operator SIX, demonstrated that a wholesale CBDC or wCBDC could be used to settle tokenised assets in central bank money.

Wholesale CBDCs can also help with cross-border settlements.

Project Jura has demonstrated successful cross-border settlement using wholesale CBDCs. The project involved the transfer of Euro and Swiss Franc wCBDCs between French and Swiss commercial banks powered by DLT (distributed ledger technology platform).

This project complements G2O's broader mandate of making cross-border transparent, efficient, and affordable. India, as a founding member of G20, can incorporate best practices from Project Jura for its wholesale CBDC project.

The Need for Retail CBDCs

A retail CBDC is a digital currency issued by a central bank directly to all users.

Surging UPI failure rates have become a cause of concern. UPI payments have a technical decline rate of 1.3 to 1.43 percent. With digital payment numbers reaching billions every month, even a 1.3 percent technical decline rate can translate into significant numbers.

A digital rupee running on UPI rails can take counter party settlement risk out of the picture, thereby reducing UPI transaction failures to a minimum.

Monetary Authority of Singapore and Reserve Bank of Australia see no immediate need for a retail CBDC. It is unclear whether RBI would go ahead with both wholesale and retail CBDC projects.

Cybersecurity Risks

The RBI is cognisant of cybersecurity risks associated with CBDCs. This week, East Caribbean CBDC DCash went offline for 15 days, impacting users. A thorough risk assessment of all cybersecurity threat vectors is needed to build a resilient CBDC infrastructure.

Central banks need to invest in building the right tech expertise and collaborate with private entities to ensure technical challenges are adequately addressed.

RBI should float a discussion paper on Digital Rupee and seek public consultation. Public-private collaboration is the way forward for a successful launch of Digital Rupee.

(Sharat Chandra is Vice President - Research & Strategy at EarthID. Opinions are personal.)