RBI Launches First Pilot Project for Digital Rupee

What’s in today’s article:

• About India’s Digital Currency Plans
• News Summary 

In News:

• The Reserve Bank of India (RBI) recently launched its first pilot project to use central bank digital currency (CBDC) in the wholesale market for secondary trade in government securities (G-secs) beginning November 1.
• Within a month, a second pilot project on retail use of the digital rupee will begin in closed user groups.

India’s Digital Currency Plans:

About a Central Bank Digital Currency (CBDC):

• If a virtual currency (be it a cryptocurrency) is recognised by the central bank it is known as the CBDC.
• CBDCs are the virtual or electronic form of fiat currencies (like the Indian rupee). Hence, a CBDC is the legal tender issued by a central bank in a digital form.
  • It would appear as a liability on a central bank’s balance sheet.
• Many countries are exploring CBDC, with the Bahamian Sand Dollar was the first to debut CBDC in 2020, while Jamaica’s JAM-DEX was the most recent.

India’s approach to virtual currencies:

• In 2018, the RBI issued a directive prohibiting banks from providing services to the cryptocurrency ecosystem.
• The Supreme Court of India overturned this decision, calling it disproportionate given that such currencies were not prohibited in the country.
• A cryptocurrency law – the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021 – that was supposed to be passed last year has yet to be enacted.
  • The bill seeks to prohibit all private cryptocurrencies in India.
  • However, it is expected to promote the underlying technology of cryptocurrency and its uses.
• Currently, there is no regulation or any ban on the use of cryptocurrencies in the country.
• In her 2022-23 Budget speech, the Finance Minister of India announced the launch of the Digital Rupee – a central bank digital currency (CBDC) – from 2022-23.

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Background:

• According to the RBI, e-Rupee can be structured as ‘token based’ or ‘account-based’.
  • A token-based CBDC is a bearer instrument, similar to banknotes, which means that whoever owns the tokens at any particular time is believed to own them.
  • In contrast, an account-based system would necessitate the keeping of a record of all CBDC holders’ balances and transactions, as well as indicating ownership of the monetary balances.
  • In a token-based CBDC, the individual receiving the token proves his ownership of the token is genuine, whereas an intermediary verifies the identity of an account holder in an account-based CBDC.
  • A token-based CBDC is preferred for CBDC-Retail since it is more similar to physical cash, but an account-based system can be considered for CBDC-Wholesale.
• The RBI is considering two models for the issuance and management of CBDCs – direct model (single tier model) and indirect model (two-tier model).
  • In the direct model, the central bank will be in charge of all aspects of the digital rupee system, including issuance, accounting and transaction verification.
  • The central bank and other intermediaries (banks and other service providers) each play their respective roles under an indirect model.
    • Here, the central bank will issue CBDC to consumers indirectly through intermediaries and any claim by consumers will be managed by the intermediary.

RBI’s announcement and its significance:

• The RBI announced that the first pilot in the Digital Rupee or e-rupee in the wholesale segment will commence in G-Secs from November 1, 2022.
• The pilot will include 9 banks: State Bank of India, Bank of Baroda, Union Bank of India, HDFC Bank, ICICI Bank, Kotak Mahindra Bank, Yes Bank, IDFC First Bank and HSBC.
• According to the RBI, the use case for this pilot is settlement of secondary market transactions in G-Secs.
• The use case for this pilot is expected to make the interbank market more efficient.
  • Settlement in central bank money lowers transaction costs by eliminating the requirement for settlement guarantee infrastructure or collateral to offset settlement risk.
• Based on the learnings from this one, a second pilot project on retail use of the digital rupee will begin in closed user groups within a month. Future pilots will concentrate on other wholesale transactions and cross-border payments.