Explainer| Is RBI planning a digital currency for India?

How will the transition to a new monetary system hold up and what are the risks?

The Reserve Bank of India (RBI) last week hinted that it will soon begin testing its own digital currency. , RBI Deputy Governor T. Rabi Sankar delved deep into the reasons for introducing a digital rupee and the possible systemic risks posed by such a currency. It is worth noting that several countries, including 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. A CBDC is no different from the cash that we hold in our wallets, except that it exists in a digital form. The CBDC will be held in a digital wallet that is supervised by the Central bank. In India, it will be the RBI that supervises the digital rupee although it may delegate some power to banks. It is unclear at the moment whether the RBI will mandate the use of the digital rupee over physical cash. Given the predominance of cash transactions in the economy, such a move looks unlikely. However, it does seem probable that the RBI will take steps to encourage the use of its digital currency over physical cash. It should be noted that the RBI’s digital rupee will not directly replace demand deposits held in banks. Physical cash will continue to be used by banks, and people who wish to withdraw cash from banks can still do so. But they can also opt to convert their bank deposits into the new digital rupee. Central banks claim that there is increasing demand for digital currencies, which they wish to satisfy. They point to the rise of private digital currencies such as bitcoin and also to the increasing use of digital payments as examples of this secular trend. Central bank digital currencies are promised as reliable, sovereign-backed alternatives to private currencies which are volatile and unregulated. Critics, however, note that the demand for private currencies comes primarily from people who have lost faith in fiat currencies issued by Central banks. They argue that governments across the world have been debasing their respective currencies by printing them in excessive amounts, thus forcing many to switch to private currencies whose supply is limited by design. So the mere digital version of a national currency like the rupee or the U.S. dollar is unlikely to affect the demand for private currencies, they believe.