Background
The Reserve Bank of India (RBI) indicated that it will soon commence limited pilot launches of e-rupee (e`), or Central Bank Digital Currency (CBDC) or digital rupee, for specific use cases.
It has hinted at two broad categories for the use of e-rupee — retail and wholesale — taking the payment system in the country to a new level where the common people and businesses will be able to use the digital currency seamlessly for various transactions.
What’s RBI’s plan?
- The central bank said that the development of CBDC could provide the public a risk-free virtual currency that will give them legitimate benefits without the risks of dealing in private virtual currencies.
- The approach for issuance of CBDC will be governed by two basic considerations — to create a digital rupee that is as close as possible to a paper currency and to manage the process of introducing digital rupee in a seamless manner.
- The central bank also feels that it is desirable for CBDCs to have offline capabilities to make it a more attractive and accessible medium of payment for a wide category of users.
- E-rupee is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different.
- It can be accepted as a medium of payment, legal tender and a safe store of value.
- The digital rupee would appear as liability on a central bank’s balance sheet.
What are the types of E-rupee?
- Based on the usage and the functions performed by the digital rupee and considering the different levels of accessibility, CBDC can be demarcated into two broad categories — general purpose (retail) (CBDC-R) and wholesale (CBDC-W), the RBI’s concept note says.
- Retail CBDC is an electronic version of cash primarily meant for retail transactions. It will be potentially available for use by all and can provide access to safe money for payment and settlement as it is a direct liability of the central bank. However, the RBI has not explained how e-rupee can be used in merchant transactions in the retail trade.
- Wholesale CBDC is designed for restricted access to select financial institutions. It has the potential to transform the settlement systems for financial transactions undertaken by banks in the government securities (G-Sec) segment, inter-bank market and capital market more efficiently and securely in terms of operational costs, use of collateral and liquidity management.
What are the forms of CBDC?
- The central bank says e-rupee, or CBDC, can be structured as token-based or account-based. A token-based CBDC would be a bearer instrument like banknotes, meaning whosoever holds the tokens at a given point in time would be presumed to own them.
- In a token-based CBDC, the person receiving a token will verify that his ownership of the token is genuine. A token-based CBDC is viewed as a preferred mode for CBDC-R as it would be closer to physical cash.
- An account-based system would require maintenance of record of balances and transactions of all holders of the CBDC and indicate the ownership of the monetary balances. In this case, an intermediary will verify the identity of an account holder. This system can be considered for CBDC-W.
What’s the model for issuance?
- There are two models for issuance and management of CBDCs under the RBI’s consideration — direct model (single tier model) and indirect model (two-tier model).
- In the direct model, the central bank will be responsible for managing all aspects of the digital rupee system such as issuance, account-keeping and transaction verification.
- An indirect model would be one where the central bank and other intermediaries (banks and any other service providers), each play their respective role. In this model, the central bank will issue CBDC to consumers indirectly through intermediaries and any claim by consumers will be managed by the intermediary.
What are the advantages of E-rupee?
- The RBI said the key motivations for exploring the issuance of CBDC in India among others include reduction in operational costs involved in physical cash management, fostering financial inclusion, bringing resilience, efficiency and innovation in the payments system.
- It will add efficiency to the settlement system and boost innovation in cross-border payments space and provide the public with uses that any private virtual currencies can provide, without the associated risks.
Can E-rupee be transacted in offline mode?
- The offline functionality as an option will allow CBDC to be transacted without the internet and thus enable access in regions with poor or no internet connectivity.
- It will also create digital footprints of the unbanked population in the financial system, which will facilitate the easy availability of credit to them.
- However, the RBI feels in the offline mode, the risk of ‘double-spending’ will exist because it will be technically possible to use a CBDC unit more than once without updating the common ledger of CBDC.
- But it can be mitigated to a larger extent by technical solutions and appropriate business rules including monetary limits on offline transactions, the central bank says.
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Steve Ovett, the famous British middle-distance athlete, won the 800-metres gold medal at the Moscow Olympics of 1980. Just a few days later, he was about to win a 5,000-metres race at London’s Crystal Palace. Known for his burst of acceleration on the home stretch, he had supreme confidence in his ability to out-sprint rivals. With the final 100 metres remaining,
[wptelegram-join-channel link=”https://t.me/s/upsctree” text=”Join @upsctree on Telegram”]Ovett waved to the crowd and raised a hand in triumph. But he had celebrated a bit too early. At the finishing line, Ireland’s John Treacy edged past Ovett. For those few moments, Ovett had lost his sense of reality and ignored the possibility of a negative event.
This analogy works well for the India story and our policy failures , including during the ongoing covid pandemic. While we have never been as well prepared or had significant successes in terms of growth stability as Ovett did in his illustrious running career, we tend to celebrate too early. Indeed, we have done so many times before.
It is as if we’re convinced that India is destined for greater heights, come what may, and so we never run through the finish line. Do we and our policymakers suffer from a collective optimism bias, which, as the Nobel Prize winner Daniel Kahneman once wrote, “may well be the most significant of the cognitive biases”? The optimism bias arises from mistaken beliefs which form expectations that are better than the reality. It makes us underestimate chances of a negative outcome and ignore warnings repeatedly.
The Indian economy had a dream run for five years from 2003-04 to 2007-08, with an average annual growth rate of around 9%. Many believed that India was on its way to clocking consistent double-digit growth and comparisons with China were rife. It was conveniently overlooked that this output expansion had come mainly came from a few sectors: automobiles, telecom and business services.
Indians were made to believe that we could sprint without high-quality education, healthcare, infrastructure or banking sectors, which form the backbone of any stable economy. The plan was to build them as we went along, but then in the euphoria of short-term success, it got lost.
India’s exports of goods grew from $20 billion in 1990-91 to over $310 billion in 2019-20. Looking at these absolute figures it would seem as if India has arrived on the world stage. However, India’s share of global trade has moved up only marginally. Even now, the country accounts for less than 2% of the world’s goods exports.
More importantly, hidden behind this performance was the role played by one sector that should have never made it to India’s list of exports—refined petroleum. The share of refined petroleum exports in India’s goods exports increased from 1.4% in 1996-97 to over 18% in 2011-12.
An import-intensive sector with low labour intensity, exports of refined petroleum zoomed because of the then policy regime of a retail price ceiling on petroleum products in the domestic market. While we have done well in the export of services, our share is still less than 4% of world exports.
India seemed to emerge from the 2008 global financial crisis relatively unscathed. But, a temporary demand push had played a role in the revival—the incomes of many households, both rural and urban, had shot up. Fiscal stimulus to the rural economy and implementation of the Sixth Pay Commission scales had led to the salaries of around 20% of organized-sector employees jumping up. We celebrated, but once again, neither did we resolve the crisis brewing elsewhere in India’s banking sector, nor did we improve our capacity for healthcare or quality education.
Employment saw little economy-wide growth in our boom years. Manufacturing jobs, if anything, shrank. But we continued to celebrate. Youth flocked to low-productivity service-sector jobs, such as those in hotels and restaurants, security and other services. The dependence on such jobs on one hand and high-skilled services on the other was bound to make Indian society more unequal.
And then, there is agriculture, an elephant in the room. If and when farm-sector reforms get implemented, celebrations would once again be premature. The vast majority of India’s farmers have small plots of land, and though these farms are at least as productive as larger ones, net absolute incomes from small plots can only be meagre.
A further rise in farm productivity and consequent increase in supply, if not matched by a demand rise, especially with access to export markets, would result in downward pressure on market prices for farm produce and a further decline in the net incomes of small farmers.
We should learn from what John Treacy did right. He didn’t give up, and pushed for the finish line like it was his only chance at winning. Treacy had years of long-distance practice. The same goes for our economy. A long grind is required to build up its base before we can win and celebrate. And Ovett did not blame anyone for his loss. We play the blame game. Everyone else, right from China and the US to ‘greedy corporates’, seems to be responsible for our failures.
We have lowered absolute poverty levels and had technology-based successes like Aadhaar and digital access to public services. But there are no short cuts to good quality and adequate healthcare and education services. We must remain optimistic but stay firmly away from the optimism bias.
In the end, it is not about how we start, but how we finish. The disastrous second wave of covid and our inability to manage it is a ghastly reminder of this fact.