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The Government of India has announced its intention to introduce a Central Bank Digital Currency (a ‘Digital Rupee’) in the 2022-23 financial year. The proposal is to issue the digital rupee using blockchain technology, managed by the Reserve Bank of India. The new blockchain based Digital Rupee will be a virtual form of the national currency, the Indian Rupee (INR). It will be exchangeable one-to-one with its physical counterpart with the two being equal in value.

In her Union Budget 2022 speech, India’s Finance Minister Nirmala Sitharaman said that a digital rupee will allow for ‘cheaper currency management’. Prime Minister Narendra Modi, in an address to his party workers said that it will strengthen the digital economy and provide a more secure and efficient means of making and receiving payments in the future.

Indian Weekender’s Dev Nadkarni spoke to Harshal Chitale on a range of aspects of the new proposed Digital Rupee. Chitale leads economic advice in his role as Principal Economist at the New Zealand Ministry for the Environment. Over his career, he has provided influential, evidence based and technically robust advise to top executives and decision makers in key industries and local and central government. His expertise spans urban, competition, environmental economics  and he also writes regular commentaries on macroeconomic issues. He is an avid watcher of the fast developing cryptocurrency and crypto-assets scenario.

What exactly is the newly announced Digital Rupee and how does it differ from other cryptocurrencies?

The digital rupee, which will be issued and regulated by the Reserve Bank of India, is fundamentally different from the thousands of private blockchain based cryptocurrencies or ‘crypto-assets’ in the market. The digital rupee will have the same backing of the Government of India that the physical currency, or fiat currency, in circulation enjoys. Private cryptos have no government backing and, in purely financial terms, do not have a sound basis for valuation, such as future cash-flows from an underlying productive asset, and as such their value is volatile and subject to large fluctuations based on market conditions and speculative capital flows.

Is New Zealand looking at a digital currency as well?

The Reserve Bank of New Zealand announced in July 2021 that it will look at the potential for a New Zealand Central Bank Digital Currency. There are several countries that have undertaken research or are at various pilot stages in their respective digital currency projects. The CBDC (Central bank Digital Currency) tracker website is a good source to gauge the status of state-issued digital currency projects across the world.

Does the Indian government’s backing give the Digital Rupee any advantage over other cryptos?

Finance Minister Nirmala Sitharaman also announced the introduction of a 30 percent tax on gains made through trade in crypto-assets, which may be a signal that the government wishes to discourage the use of private cryptocurrencies which have gained significantly in popularity and adoption over the past 12-18 months.

What are some of the benefits of the Digital Rupee?

One of the potential benefits of a Digital Rupee could be the lower or indeed the avoided costs of printing, storing and distribution of the currency compared to its physical counterpart. However, there will be sizeable expenditure in building, maintaining and securing the technological infrastructure that hosts the digital rupee blockchain.

Also, the claim that the digital rupee will make payments more efficient and secure is a debatable one and requires more research. Apart from the elimination of intermediary merchant fees, it is unclear how a blockchain-based payments system will be an improvement over the currently available digital payment options. In particular, with the introduction of the Universal Payments Interface (UPI) people have the ability to link any of their bank accounts, debit and credit cards to make or receive payments instantaneously and securely.

Indian government benefits and welfare payments have already been streamlined through the Jan Dhan scheme which eliminates intermediaries and transfers benefits such as pensions directly to the beneficiaries’ bank accounts. The scheme claims to have benefited 445.8 million beneficiaries since its inception, a staggering number who now have access to a range of digital payment options.

Many people find it hard to get their heads around cryptocurrencies and the blockchain technology that drives them. Do you see that as an impediment to the uptake of the Digital Rupee?

There will likely be need for a significant continuous educational campaign to help onboard people on to the digital rupee network and train them to carry out transactions using their digital wallets. A key threat to the level of trust and the security of the blockchain will be the rise in cyber-attacks globally. In the extreme, a government-issued digital currency could be a prime target for such attacks and compromise on national security.

What features of the Digital Rupee would be critical for it to succeed?

Blockchain transactions need to be verified in a decentralised manner and whether the blockchain will be able to do this instantaneously remains to be tested. For certain transitions, a delay may be tolerated by the parties, but for a large chunk of them, instant execution of the exchange would be a critically desired feature of the technology. Without instantaneous execution, the level of buy-in may be severely limited.

Another issue that could limit the adoption of this blockchain based currency is the fixed and mobile broadband coverage across the country. Without fast and secure internet connectivity, blockchain used payments may be too hard to execute. Unless addressed, these issues may well have the perverse effect of widening the ‘digital divide’.

One of the important features of digital transactions is the transparency it affords, especially to the authorities. Would this prove a deterrent in some quarters?

One of the claimed benefits of a digital currency is the increased ability to monitor transactions which may help limit the size of the parallel economy [commonly referred to as the black economy] which by some estimates is significant. However, trust in the digital currency will be severely compromised if people fear that their privacy is being intruded upon by the government in any way via an ability to monitor transactions. The Chinese government has full visibility of every digital yuan (the digital yuan is in its pilot phase currently) transaction even though the parties to the transaction may not have access to each other’s private information. This will be almost impossible to sustain in India.

Is the Indian economy ready for something like the Digital Rupee?

At this stage, details on the precise technology to be used in order to verify transactions on the blockchain, the network infrastructure required for traders to be able to transact with counterparties and the role of commercial banks once the digital rupee is introduced are scarce.

The government is clearly aware of the potential for private crypto-assets, particularly stablecoins, to grow in adoption and threaten the existence of the Indian rupee issued and controlled by the Reserve Bank in the future. The introduction of a tax on gains made in the trading of private crypto-assets is a clear signal that the government wishes to direct people away from them and the Digital Rupee might be the direction they want people to turn towards.

However, at this stage, the problems that the Digital Rupee wishes to solve and whether it will be successful in solving them and yield benefits of a scale that outweighs the costs and risks associated with it is unclear. It would be advisable for the government to undertake a full cost-risk-benefit analysis and engage the public in a consultation before launching into the development phase of the digital currency. Rushing to introduce it might lead to low trust and adoption which might be too difficult to recover from in the future.

So in a sense, this may well be a case of a solution looking for a problem.

First appeared in the February 19 issue of the Indian Weekender.