What a digital currency from RBI must get right

Livemint     26th July 2021     Save    
QEP Pocket Notes

Context: A trial Central Bank Digital Currencies (CBDC) would need to assess the impact of its launch on financial intermediation, how well it assures users privacy and our economic exposure to its effect on cross-border flows.

Reasons behind renewed interest in CBDCs

  • Heightened risk from frenzied trading in cryptocurrencies: This could sow seeds of future instability. Cryptocurrency risk arises from-
    • The practice of exhorting people to invest and trade in cryptos without providing basic information about the product.
    • Aggressive outreach to retail investors who stand to lose a large proportion of their savings should markets turn.
    • No backing: They do not have any intrinsic value, and, as things stand, their tradeable value is determined by an artificial shortage that has led to extreme volatility.
  • Consequences of the rapid spread of technology and growing acceptance of alternative payment solutions: There is a growing need for virtual currencies and e-wallets.
  • Furthering regulation of cross-border transactions: This is uncharted territory, with no proper risk mapping and where cryptocurrencies are finding major applications.

Challenges ahead for CBDCs

  • Potential adverse impact bank on deposits and bank credit: As CBDCs can be efficient disintermediation vehicles for retail savers. Limiting retail and institutional CBDC holdings through either hard limits or monetary disincentives needs further consideration.
  • Privacy issues: Blanket of anonymity CBDCs offers and excessive state interventions into people’s lives need to be balanced.
  • Managing cross-border flows vis-à-vis CBDCs: Necessary to address volatility because these impacts inflation and growth.

Conclusion: RBI needs to create a sandbox, with limited participants and pre-specified uses, before launching its own digital currency.

QEP Pocket Notes