By: Tejaswini Kaushal*

INTRODUCTION

Dozens of nations, including Australia, China, the United States, Bahamas, Jamaica, and Nigeria, have successfully launched their Central Bank Digital Currencies (“CBDCs”). At the same time, more than a hundred countries are actively engaged in researching, developing, or piloting their own CBDCs. This digital transformation reflects a global shift towards a more efficient and technologically advanced monetary landscape.

India has most recently joined their ranks. Despite the country’s appreciation for tangible cash, the COVID-19 pandemic has accelerated the country’s adoption of digital transactions, leading to the digitization of securities, transactions, and communications. During the presentation of Budget 2022, the Finance Minister unveiled the CBDC for India, colloquially termed the ‘e-rupee’ (e₹) or ‘digital rupee.’ This digital form of the official currency is backed by the Reserve Bank of India (“RBI”) and replicates nearly all the features associated with physical cash, albeit in a digital format. The RBI has initiated pilot programs for the two variants of CBDC – CBDC-W (wholesale) and CBDC-R (retail) – in the Indian market.

This article analyzes the potential success of this initiative in light of lessons from other jurisdictions to determine whether India will indeed achieve its envisaged objectives through the e-rupee or will end up in shambles, similar to many other nations. The article will first acknowledge the intended as well as collateral benefits expected from the e-rupee. Subsequently, it will highlight and address the challenges currently impeding the e-rupee or potentially emerging in the future that may hinder its adoption. Lastly, the article will assess the scope and feasibility of a CBDC in India, as well as the likelihood of its widespread adoption and use.

THE SILVER LININGS 

As per the concept note released by RBI, the e-rupee system is poised to fortify India’s digital economy, elevate financial inclusion, and optimize monetary and payment systems. The advantages of this digital official currency for the Indian economy encompass efficient transfers, minimal transaction costs, immunity to physical damage, expedited fund settlements, reduced downtime, 24/7 accessibility without the necessity of a bank account, seamless cross-border transactions, and cost-effective operations akin to other digital payment mechanisms.

Furthermore, the following aspects specifically stand out as primary drivers motivating the government’s foray into digital currency:

(a) Curtailing Volatility

The introduction of CBDCs is set to revolutionize India’s currency management system, enhancing efficiency and economic viability. Regulated by the RBI, CBDCs offer a stable alternative to the volatility seen in other digital currencies. The financial system’s settlement risk is significantly reduced by facilitating digital currency payments. The reliance on interbank settlements diminishes as digital currencies transact directly, mirroring the simplicity of cash transactions. Real-time forex transactions further exemplify this efficiency, eradicating settlement risk and allowing seamless cross-border payments. Digital currencies pave the way for a real-time, cost-effective globalization of payment systems.

(b) Improved Velocity

The digitization of India’s payment system has ushered in various avenues for the digital movement of funds and to cater to diverse transaction purposes. The accelerated flow of money, facilitated by digitization, holds immense promise for the Indian economy, as the velocity of money circulation serves as a key indicator of economic dynamism. In aspiring to be a superpower with a substantial GDP, India stands to benefit from the swift movement of money, making digitization the preferred route, and CBDC is a pivotal step forward. The emphasis on creating newer, secure, convenient, and easy-to-use CBDC forms underscores the nation’s future trajectory toward this objective.

This efficiency extends to the retail sector. Various payment system operators, wallet companies, and service providers have contributed to this growth, offering customers an expanded array of choices and driving profitability. The RBI’s support, particularly through the Real Time Gross Settlement (RTGS) and National Electronic Funds Transfer (NEFT) systems for large values and retail transfers, respectively, has been instrumental. The Unified Payments Interface (“UPI”) by the National Payments Corporation of India has further propelled real-time, interbank, peer-to-peer, and person-to-merchant transactions, solidifying India’s position at the forefront of digital payment innovation. CBCD will further facilitate these measures by allowing transactions to be undertaken even in the absence of internet connectivity, where other digital payment apps tend to fail.

(c) Trailing Transaction

While CBDCs could potentially include those currently excluded from financial services, the associated costs are substantial, and there is limited acknowledgment that central banks are willing to bear this burden. The most significant motivation here for central banks to embrace CBDCs is the crackdown on money laundering and other financial crimes. Transparency is a key hallmark of digital crypto transactions in today’s landscape. This was similarly present in traditional cash transactions. However, the audit trail accompanying digital transactions provides a clear record of identity, purchases, and location. This will help government track transactions across the nation to a tee.

(d) Countering Cryptocurrency

A significant impetus for the government’s pursuit of digital currency also arises from the exponential growth of cryptocurrencies and investor participation in recent times. The proliferation of a parallel economy fueled by crypto investments, coupled with financial sanctions in the aftermath of geopolitical events like Russia’s invasion of Ukraine, has spurred several nations to embark on digitization and establish their own digital currency. The rise of cryptocurrency has raised concerns among countries, including India, about maintaining monetary sovereignty. CBDCs offer a viable alternative, especially in response to dollar-backed stablecoins.

CBDCs present distinct advantages over private cryptocurrencies like Bitcoin and Ethereum to users as well, based on which the government anticipates that the public will shift from cryptocurrency to CBDC. Firstly, CBDCs are recognized means of payment with legal backing, unlike their private counterparts. This legal status ensures that a CBDC can fulfill payment obligations reliably, a capability lacking in private digital currencies. Secondly, the ownership and quantity of private digital currencies remain uncertain, with the issuing entities of major cryptocurrencies shrouded in mystery. In contrast, a digital currency issued by a central bank is typically backed by a sovereign nation, providing holders with confidence in the stability and accessibility of its value, even in the face of unforeseen contingencies or IT system issues.

THE LOOMING CLOUDS

(a) The Recognition Paradox

The RBI has yet to officially define the term “cryptocurrency,” opting to crudely categorize it, along with non-fungible tokens (NFTs), as a virtual digital asset, similar to a share of stock, solely for tax purposes. Within the same 2022 Budget, the Finance Minister suggested a 30 percent tax on “any income from transfer of any virtual digital asset.” Despite the RBI’s reservations about cryptocurrencies, it is simultaneously exploring the potential for a CBDC, which also utilizes blockchain technology. The Finance Secretary clarified that while India’s digital currency, backed by the RBI, will be legal in the country, cryptocurrencies like Bitcoin and Ethereum will “never become legal tender” in India.

However, this stance of the RBI is riddled with internal contradictions and dampened coherence of the RBI’s intentions. Furthermore, in the case of Internet and Mobile Association of India v. Reserve Bank of India (2018), where the Supreme Court held that a total ban on trading in virtual currencies was disproportionate and excessive, the court also commented that it is utterly paradoxical that blockchain technology is deemed acceptable by the RBI while cryptocurrency faces ambiguity. This method of selective recognition by the RBI is unlikely to go far.

(b) Improbable Financial Inclusion

A primary objective of the CBDC initiative is to foster financial inclusion. In a world where traditional banking services remain elusive for many, CBDCs are often hailed as a promising solution to bridge the existing gap. According to the World Bank, approximately 1.7 billion adults still lack access to a bank account despite a global decline in cash usage. CBDCs, accessible through mobile phone e-wallets, can enhance financial inclusion by promoting the adoption of digital payments, especially in markets where private sector motivation may be insufficient.

Furthermore, over a million users and 262,000 merchants had enrolled in the pilot for retail CBDC transactions as of June 30, 2023. Industry experts hail CBDCs as transformative catalysts, reshaping financial inclusion and providing a safer, more affordable avenue for economic transactions. By granting access to the formal financial system, CBDCs empower the unbanked, making micro-transactions viable, promoting financial independence, increasing saving propensity, and integrating users into the mainstream banking framework.

Two key factors support this assertion. Firstly, CBDCs leverage blockchain technology, incorporating encryption and decentralized ledgers to secure financial transactions. This inherent security not only shields individuals from fraud and cyber threats but also fosters confidence among the unbanked and underbanked, encouraging active participation in the digital economy. Secondly, CBDCs are inherently affordable, eliminating financial barriers and providing a cost-effective means of conducting transactions, particularly for those with limited access to cash.

CBDCs do give hope for a future where financial services become a fundamental right rather than a privilege, ensuring prosperity knows no bounds. However, it is crucial to acknowledge the potential downsides that may deter some from transitioning to CBDCs:

i. An Insufficient Incentive to Switch

There has been a notable surge in digital transactions in India, particularly through the UPI. In October 2023 itself, UPI recorded over 7 billion transactions amounting to approximately $150 billion. UPI has been pivotal in broadening access to banking services and welfare programs. In this context, the International Monetary Fund has noted the striking similarities between CBDCs and instant payment systems, suggesting potential limitations on using new digital currencies.

Despite the promising trajectory, customer adoption has not been uniform. Even though e-rupee is supposedly resilient to internet errors, many vendors report sporadic functionality. This limits customer confidence in its reliability. Certain vendors even claim minimal user engagement, primarily restricted to bankers testing the system. These instances are not unique and have been faced by most countries that issued CBDCs. For instance, when the Bahamas launched the Sand Dollar in 2020, low adoption was reported simply because many Bahamians continued to favor debit and credit cards. What becomes most important for India in such a case is that the RBI addresses these issues ante omnia.

ii. The Anonymity Factor

As digitization advances, concerns about privacy and security become more pronounced. Privacy emerges as a primary apprehension, particularly with CBDCs, as most are designed to operate within existing financial systems. For instance, China’s digital yuan, or e-CNY, tested in various cities and used at the 2022 Winter Olympic Games, raised concerns about surveillance and control.

It is crucial to recognize that no digital currency is truly anonymous. Be it GPay, Apple Pay or a debit card, all transactions through these modes can be tracked. Unlike cash, which is largely untraceable, CBDCs also require identification. India’s Digital Personal Data Protection Act, 2023, with broad exemptions for government access under Section 17, propounds this phenomenon.

The RBI acknowledges the challenge, stating that achieving the same levels of anonymity and privacy as physical cash is highly unlikely. However, to preserve this fundamental characteristic of currency, there’s potential for legal provisions to ensure anonymity for the e-rupee. Though the level of anonymity for CBDC transactions is not specified, it can be anticipated to align with Section 269ST of the Income Tax Act, 1961, which restricts cash transactions over Rs 2 lakh in a single day or in aggregate from a person pertaining to one event or occasion, without requiring identity proof. However, greater clarity on this from the RBI will be appreciated in allaying public concerns.

iii. Cybersecurity Woes

Concerns over cybersecurity loom as the minutest of vulnerabilities in the CBDC could leave people exposed. Developed without transparency and citizen participation, the e-rupee faces risks similar to other CBDCs worldwide, and the anticipated risks are severe in impact and volume. Digital currency risks primarily revolve around potential attacks on the IT platform, such as hacking individual accounts or cyber assaults on the entire system. Unlike physical currency, which is vulnerable to theft, the e-rupee demands robust mechanisms, adequate safeguards, and backups in both the physical and digital sapce. Multi-layered security checks at each transaction stage are essential, with a broader system capable of withstanding diverse cyber threats. Individual users must exercise caution, employing proper safeguards for password protection, OTP, and device security.

Double-spending scams, exploiting protocol issues or software vulnerabilities, pose risks for most digital currencies, including the Digital Rupee. The project’s desirable “offline capabilities” bring the risk of double-spending, necessitating the establishment of a trusted fenced system to mitigate potential fraud. This is exemplified by the 2016 Bangladesh Bank heist, where hackers manipulated the system to generate fraudulent payment orders, leading to the unauthorized withdrawal of $81 million from the Bangladesh Bank’s accounts. This called into question their negligence and prompted authorities to update and consistently maintain their security systems.

(c) Banker Reluctance

Bankers express uncertainty about the e-rupee, noting a perceived drawback in individual settlement for each trade, lacking the netting efficiency of established interbank systems. A private bank executive emphasizes the absence of advantages over internet-based transactions, labeling the lack of netting as a significant drawback. Additionally, integrating e-rupee transactions with existing procedures contributes to increased accounting work for banks.

Despite incentives such as cashback and reward points being offered by bankers to e-rupee users personally, bankers cite inefficiencies and low trade volumes, questioning the potential adoption of e-rupee post-pilot without RBI pressure. A case study in point is the failure of the e-Naira in Nigeria. Despite the Nigerian government’s attempts to boost CBDC adoption with measures like removing access restrictions and offering discounts for CBDC payments, all efforts proved unsuccessful, and the population continued to favor cash or digital payments over digital currency. Evidently, a country cannot simply legislate a changed behavior into its citizens as long as the risks outweigh the benefits for CBDC and deter voluntary adoption. It has to be chosen and not forced upon the stakeholders, or the results are riots and suffering.

SETTING THE PACE FOR A DIGITISED FUTURE 

The introduction of CBDC in India was a move sine qua non, particularly given the escalating digitization measures globally. Undoubtedly, this step was bound to occur within this decade, and the sooner it transpires, the better. India’s initiation of a pilot program holds immense significance, considering it is one of the world’s largest economies, thereby inspiring other nations to follow suit. This solidifies India’s position as one of the foremost global superpowers.

The adoption of CBDC will hinge significantly on its appeal to Indian citizens, which could serve as a catalyst for widespread usage. From the author’s perspective, CBDC may not entirely replace cash in India anytime soon, given its current trajectory. Instead, it could exist as a viable alternative, allowing both physical and digital currency to coexist. But then again, even for the RBI, the primary objective of CBDC is to complement, rather than replace, existing forms of currency. However, the author believes that maintaining the coexistence of physical, paper-based currency alongside digital currency is not feasible to achieve the nations’ long-term visions, and a strategy for adoption at the very nascent stage must aim for goals that facilitate the long-term vision of complete digitization. The success of RBI’s upcoming digital currency will lie in addressing this incongruity soon and offering solutions to facilitate a complete and thorough shift in the mode of transactions.

Additionally, the author anticipates that the sentiments of nationalism and support for homegrown digital initiatives by the Indian public will play a pivotal role in e-rupee adoption. Indians have previously demonstrated similar positive nationalist sentiments during the widespread adoption of the indigenous Koo App as retaliation to Twitter in 2022, successfully propelling it to the second position in microblogging platform popularity.

While the e-rupee can somewhat bank on the appeals to the Indian public on the grounds of sentimentality, it is equally crucial to acknowledge the caveat of these emotional motivators faltering quickly enough if the product fails to meet long-term practicality and utility expectations. This was evident in the case of Koo as well, which experienced a decline in its monthly active user base since its peak in July 2022. Koo’s monthly active users dropped from 9.4 million in July 2022 to 3.1 million in April 2023. There are also reports suggesting that, with funding out of reach, Koo was exploring a strategic sale. To prevent a similar trajectory of growth for the e-rupee, the government must devise a sound strategy that entails an assurance that the CBDC aligns with the practical needs and utility expectations of the population, thus avoiding potential pitfalls in its adoption journey.

*Tejaswini Kaushal is a law undergraduate at Dr. Ram Manohar Lohiya National Law University, Lucknow. The author may be contacted via mail at tejaswinikaushal12@gmail.com.