Ecomatrix-Wells Fargo

Central bank Digital Currency (CBDC) is a digital form of currency notes issued by the Reserve Bank
of India. These currencies are digital tokens, similar to cryptocurrencies but it is issued by RBI. They
are pegged to the value of the India’s fiat currency. It is to be considered as legal tender that can be
used to exchange goods and services. Conventinally, fiat money came in the form of banknotes and
coins, but artificial intelligence, deep learning, and modern technologies allowed financial institutions
and governement to supplement physical fiat moneywith the “credit-based model” in which balances
and transactions are recorded digitally. There are broadly two types of CBDC that are Retail CBDC and
Wholesale CBDC.Wholesale CBDC is intended for the settlement of interbank transfers and related
wholesale transactions, Retail CBDC is an electronic version of cash primarily meant for retail
transactions.

Motivation for the issue of digital form of currency

The Covid-19 pandemic has forced financial institutions to consider safer, non-transferable banknotes
and coins. Cryptocurrency and blockchain have increased interest in cashless societies and digital
currencies. CBDC, being a sovereign currency, holds unique advantages of central bank money, viz.
trust, safety, liquidity, settlement finality and integrity. The main reasons why India is looking into
issuing CBDC are, among other things, to lower the operational costs of managing physical cash,
increase financial inclusion, add resilience, efficiency, and innovation to the payments system, make
the settlement system more efficient, encourage innovation in the cross-border payments space, and
give the public the same uses that private virtual currencies can, but without the risks. The use of the
offline feature in CBDC would also be beneficial in remote locations and offer availability and
resilience benefits when electrical power or mobile network is not available. CBDCs will provide the
public with the benefits of virtual currencies while ensuring consumer protection by avoiding the
damaging social and economic consequences of private virtual currencies/ Crypto Currencies. CBDC
when compared to unbacked crypto assets that are inherently volatile.

Need for CBDC in banking systems and financial institutions and its features

CBDCs are needed worldwide to accelerate payments, digitise, and reduce clearing and settlement risk.
Financial inclusion and efficient domestic and cross-border value transfers are also needed. Many
Central Banks and governments are now exploring a digital fiat currency. Four main reasons Central
Banks evaluate CBDCs besides using them to influence monetary and fiscal policies are, CBDCs are
real-time, gross, and final. This eliminates interbank settlement and reconciliation because it lowers
financial system settlement risk. CBDCs may enable real-time, cost-effective payment system
globalisation. No "Herstatt" risk in currency settlements. CBDCs can enable smart contracts to enable
"atomic" transactions, where the transfer of CBDCs with another asset is contingent on the real-time
transfer of the other asset. In a multi-currency CBDCs environment, this would enable Payment versus
Payment (PvP) for cross-currency transactions or Delivery versus Payment for domestic transactions if
the other asset is a physical or financial asset. Cash costs Sweden 0.5% of GDP and India 1.7%.
Households, businesses, banks, and the Central Bank shoulder this cost, which does not include the
ESG cost of printing money. Another consideration is improving tax efficiencies, which in India are
expected to account for 3.2% of GDP . CBDCs improve clearing, settlement, and post-market
activities. This digital money would boost efficiency and lower reconciliation costs. The features that
make CBDC appealing that are, soverign currency issued by central bank, liablity on central bank’s
balance sheet, accepted as a medium of payment or legal tender, freely convertible against cash, holders
need not have a bank account, lowers cost of issuance of money and transactions.

CBDC and its effects on inflation

The money multiplier for CBDC will be much more than banknotes or coins. The increase in money-
multiplier causes the money supply to increase in the money base cause the money supply to increase
by a multipier amount. All the tools are given by monetarists to control inflation i.e., CRR, SLR, REPO
Rate, and Reverse repo rate are of no use in digital transactions as the there is neglegible time lag
between issue and circulation. Money velocity increases inflation. Cash velocity increases inflation. To
avoid inflation, cash currency must be matched by physical supplies. Digital currency includes this.
digital money into the economy, all onshore banks represent the central bank. Before digital banking,
multiplier and velocity effects were needed because most banking transactions were cash and cheque
transactions and there was not enough physical cash to distribute (money supply lag). In the digital era,
currency is unnecessary. Because every activity will be transparent in the digital banking infrastructure
ledger spreadsheets, this might be zero taxation.Money velocity increases inflation. Cash velocity
increases inflation. To avoid inflation, cash currency must be matched by physical supplies. Digital
currency includes this. Banks must replace cash with digital rupees to spread digital money. Given the
5.5 money multiplier effect currently caused by cash transactions, if we issue one unit of digital
currency, we would not need to take out 5.5 units of cash because each unit produces only one unit of
physical supply and becomes exhausted. Allowing velocity and multiplier effect would grow physical
things proportionally. The multiplication effect requires 5.5 supply units per digital issue. This
eliminates inflation and deflation. Leakage in demand-supply pipes can induce inflation and deflation
from saving and taxing. Market digital currency would decrease/increase. Supply pipeline savings
reduce production, causing inflation. Less physical supply causes inflation. However, demand pipeline
saving deflates. Banks should create interest rates and save all savings digitally. This money can be
accessed online and spent on non-inflationary goods and services. Another way to curb inflation is to
issue digital money to existing factories that make inflation-causing commodities, and in the short term,
digital currency imports can cover the time lag.

CBDC management and innovation in digital currency

Money is transforming the economy's financial environment. With cutting-edge technologies,

digitalization of money is the next monetary milestone. Technology has made Central Bank Digital
Currencies conceivable. Central banks around the world are considering establishing a CBDC to keep
up with technology-based payments alternatives. RBI has been weighing the advantages and cons of
CBDCs for some time and is currently working on a phased deployment approach that involves pilots,
a final launch, and use cases for its own CBDC, the Digital Rupee, with minimal financial system
disruption. We are at the forefront of a monetary revolution that will transform money and its uses.
Reserve Bank broadly defines CBDC as central bank-issued digital legal money. It resembles sovereign
paper currency but is different, exchangeable at par with the current currency, and acknowledged as a
medium of payment, legal tender, and safe store of value. CBDCs would be central bank liabilities.
Bank for International Settlement has established "foundational principles" and "fundamental
elements" of a CBDC to guide inquiry and support public policy objectives. The core principles state
that authorities must be convinced that issuance will not jeopardise monetary or financial stability and
that a CBDC could coexist with and complement existing money, supporting innovation and efficiency.

Impact on monetary and fiscal policy and its opportunities

The introduction of CBDCs could serve as an impetus to improve the monetary policies for Central
Banks. Its architecture and structure could allow for the seamless and transparent distribution of
government benefits to individuals, improving control over transactions. CBDCs would improve and
enhance financial stability by managing liquidity squeezes and providing the public with alternatives to
cryptocurrencies. CBDCs potentially reduce identity theft risk, as the digital trail would ensure
traceability and enhanced security. CBDCs could enable Central Banks to protect purchasing power to
maintain the real value of money in the economy. For example, under an indexation scheme, the
nominal value of an individual’s CBDCs holdings may be incentivized during periods of higher-than-
expected inflation. The digital nature of CBDCs will allow Central Banks to tap into more granular
payment flow data across an economy which in turn would enhance macroeconomic data integrity and
analytics. CBDCs are not expected to replace cash completely but to provide users with a new digital
form of money and a way of making payments.

Opportutnities of CBDC to support monetory and financial policies

The CBDC reduced the risk of new form of private money creation. CBDC will help in suppoting
competition efficiency and innovation inpayments. The fulfils the future payment needs in digital
economy. It also helps in effective utilization and avilability of the central bank money. It helps in
cross-border payments. It suppoert the resilient payment landscape and addresses the consequencesof
decline cash.

Limitations and the way forward

82.5 crore Indians are internet users. Connectivity issues prevent many Indians from using CBDCs.
CBDC needs offline capabilities to be widely used. CBDC ecosystems may face cyberattacks like
payment systems. The item and environment need cybersecurity considerations. To maintain a trusted
environment, token transactions must be safeguarded, even while token production should use the
greatest levels of cryptography.
Journey map of CBDC globally and growth
References

https://www.rbi.org.in/

https://www.imf.org/en/Publications/fandd/issues/2022/09/Picture-this-The-ascent-of-CBDCs

https://blogs.worldbank.org/allaboutfinance/central-bank-digital-currency-right-tool-expand-financial-
inclusion

https://wwwcbdctracker.org/