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Central banks, block the odd occasion, are rarely known for competing among themselves. The evasion 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 polygonal compact that led to the ‘taper tantrum’ of 2013. And now, in an attempt to keep up with the persistent march of technology and to ward off intruders from muscling into central bank territory, many of the world’s central banks are racing to launch their own simulated currencies, or central bank digital currencies (CBDCs).

The Reserve Bank of India is working on a phased execution strategy for its own digital currency and is in the process of launching it in wholesale and retail segments in the near future. A top-level inter-ministerial committee set up by the Finance Ministry had recommended Central Bank Digital Currency (CBDC) with changes in the legal framework including the RBI Act, which currently empowers the RBI to standardize issuance of bank notes.

The idea of “Central Bank Digital Currencies” (CBDC) is not a contemporary development. Some attribute the origins of CBDCs to Nobel laureate James Tobin, an American economist, who in the 1980s recommended that Federal Reserve Banks in the United States could make available to the public an extensively accessible medium with the expediency of deposits and the safety of currency. It is only in the last decade, however, that the notion of digital currency has been widely conversed by central banks, economists & governments. Except as currency notes, all other use of paper in the modern financial system, be it as bonds, securities, transactions, communications, correspondences or messaging has now been replaced by their corresponding digital and electronic versions.

On circumstantial evidence, the use of corporeal cash in transactions has been on the deterioration in recent years, a drift further armoured by the ongoing Covid19 pandemic. These signs of progress have occasioned many central banks and governments pacing up efforts towards discovering a digital version of currency. Some of this interest among central banks has been native in nature for pursuing precise policy objectives – for example, facilitating negative interest rate monetary policy. An additional driver is to offer the public virtual currencies that carry the genuine benefits of private virtual currencies while avoiding the detrimental social and economic magnitudes of private currencies.

A 2021 survey by the Bank for International Settlements (BIS) found that 86% of central banks were actively researching the latent for CBDCs, 60% were trialling the technology and 14% were deploying pilot projects. CBDCs can also cause a decrease in transaction stipulation for bank deposits. Since transactions in CBDCs decrease settlement risks, they reduce the liquidity needs for settlement of transactions, and by providing a genuinely risk-free alternative to bank deposits, they could cause a shift away from deposits, which in turn might decrease the need for government assurances on deposits.

The RBI has been determining the pros and cons of the initiation of CBDCs for some time. RBI will also draw upon the lessons from other countries that are in numerous stages of introducing such a digital fiat currency. The institution of CBDC would unlikely obstruct the usage of cash, but if obscurity is ensured, then transactions can switch over from cash to digital means. India’s high currency to GDP ratio holds out another advantage of CBDCs. To the degree great cash use can be substituted by CBDCs, the cost of production, conveying, storing, and allocating currency can be abridged. Earlier, the deputy governor had said that the RBI will introduce its own kind of CBDC in a phased manner after sensibly pondering its impact on various issues, including how it could hinder the deposit mobilisation abilities of banks, and its possible effect on the conduct of the monetary policy. However, he had mentioned that leading pilots in wholesale and retail segments may be a possibility in near future.

While the RBI is working towards bringing out a CBDC, they have solemn trepidations when it comes to private virtual currencies. The RBI has made its standpoint clear on cryptocurrencies, saying it has chief concerns around such assets, reiterating its long-standing position on the use of virtual currencies. The Deputy Governor had said lawful changes would be essential as the current provisions have been made keeping in mind currency in a physical form under the Reserve Bank of India Act. He also emphasized some of the risks linked with digital currencies, like an abrupt flight of money from a bank under stress. There are associated risks but they need to be prudently evaluated against the possible benefits," he added. He said momentous amendments would also be prerequisites in the Coinage Act, Foreign Exchange Management Act (FEMA) and Information Technology Act.

There is an assumption already that Central banks will cap the sum of money that an individual can hold in the form of CBDCs. This is to avert the mass drawing of deposits from banks. Some even consider that some Central banks may levy a negative penalty on their digital currencies. This could be done to force people to spend their digital currencies and to dampen the drawing of deposits from banks that impose negative interest rates. But it can also lead to extensive money creation by banks since they no longer need to worry about the peril of a depositor run when they generate too much money.