Central banks, bar the odd occasion, are seldom known for competing among themselves. The default mode over the past few decades has been to coordinate actions, given the global economy’s inter-connectedness and border-defying financial flows. The odd occasion, though, has been the US Federal Reserve’s breach of this multilateral compact that led to the ‘taper tantrum’ of 2013. And now, in an attempt to keep up with the relentless march of technology and to ward off interlopers from muscling into central bank territory, many of the world’s central banks are racing to launch their own virtual currencies, or central bank digital currencies (CBDCs). Even the Reserve Bank of India (RBI) “…is currently working towards a phased implementation strategy and examining use cases which could be implemented with little or no disruption,” according to a recent speech by its deputy governor T. Rabi Sankar. There are many reasons behind this rush to create CBDCs, but a compelling factor is the heightened risk from frenzied trading in cryptocurrencies, which could sow the seeds of future instability.
India has also seen the emergence of cryptocurrency exchanges, which have mined grey zones of regulation. Most of these are exhorting people to invest and trade in cryptos without providing basic information about the product and the inherent risks. Even more dangerous is the aggressive outreach to retail investors who stand to lose a large proportion of their savings should markets turn. Cryptocurrencies are not backed by any commodity. 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. That said, with the rapid spread of technology and growing acceptance of alternative payment solutions, there is indeed a growing need for virtual currencies and e-wallets. Many cryptocurrencies are claiming to be the ideal substitutes for traditional currency, especially for cross-border transactions. This is uncharted territory, with the no proper risk mapping, especially for smaller economies with relatively vulnerable currencies. CBDCs certainly have a role to play here. The PwC Global CBDC Index shows more than 60 central banks in various stages of launching a digital currency.
However, CBDCs still need wrinkles ironed out. Three issues require scrutiny. One, if CBDCs are indeed efficient disintermediation vehicles for retail savers, this could adversely affect bank deposits and eventually growth of bank credit. Some central banks are contemplating ways of limiting retail and institutional CBDC holdings, through either hard limits or monetary disincentives. This needs greater public discussion. Two, given the public preference for cash and the comfortable blanket of anonymity it offers, CBDCs have to create foolproof systems for privacy protection; recent developments have left the public wary of excessive state intervention in their lives. Three, central banks will have to figure out how to manage cross-border flows vis-à-vis CBDCs and the attendant volatility because these eventually impact inflation and growth. Other central banks have started experimenting with either retail or wholesale CBDCs. RBI too needs to create a sandbox, with limited participants and pre-specified uses, before launching its own digital currency. Only then can the rupee hold its own against other currencies.