Digital currency and fail-safe wireless connectivity should have preceded demonetisation
On December 1, the Reserve Bank of India (RBI) introduced a digital rupee (DR), which is also known as the central bank’s digital currency (CBDC). The RBI has authorised four scheduled commercial banks to operationalise the DR in a pilot project mode. Instead of stocking cash for payments, Indians would be able to use DRs to square accounts with other individuals and entities. Henceforth, to make cash payments, individuals, micro, medium and small enterprises (MSMEs) or others would not need to draw cash from their accounts, by going physically to their banks or to ATMs. They could instead send or receive DRs once they have registered for this service with the banks authorised to provide this facility. It is noteworthy that users of DRs are not required to open an account in any bank.
Of course, a moot question is, why would anyone keep a sizeable amount in DRs since this is equivalent to cash and would not accrue interest as do balances in savings accounts? On the other hand, an advantage of using DRs is that these may be acquired without having a bank account. Banks would benefit as they would not have to pay interest on stocks of DR balances. For the RBI, the use of DRs would result in savings on financial costs and the oversight time spent in printing rupee notes and destroying these at periodic intervals.
The elimination of unaccounted cash holdings was one of the objectives of the November 2016 demonetisation exercise. At that time, the entire volume of Indian rupees (INR) in circulation in the country amounted to about Rs 15 trillion. As of December 2, 2022, the total amount of INR cash liquidity stood at Rs 32 trillion. In other words, in December 2022, cash in the Indian economy was 2.13 times that in November 2016. Over the same time period, India’s nominal gross domestic product (GDP) went up by 1.7 times. This is not to suggest that there is anything unwarranted with a somewhat higher rise in the volume of rupees in circulation compared to the growth in GDP between November 2016 and December 2022. The objective of this comparison is to demonstrate that one of the objectives of demonetisation — to reduce illicit monetary transfers by contracting the volume of cash in the economy — has not been met yet.
Turning to the advantages of using DRs, current users of cash would be able to make or receive sizeable payments in DRs without complaints about torn or counterfeit notes or that the funds were not received at all. Of course, cashless transactions are possible via easy-to-use mechanisms such as Paytm and Google Pay. The distinction between DRs and other means of transferring funds is that except for DRs, all other mechanisms require both senders and receivers to have bank accounts. Those who wish to use DRs would only need to set up DR balances with banks, which would be debited or credited with the use of this facility to pay or receive funds. Banks would need to ensure fail-safe systems for the exchange of DRs to build confidence. However, this facility would work only if the users have easy and uninterrupted access to the internet. It is being suggested that transactions could be allowed without internet connectivity but that may result in multiple DR payments without adequate DR credit balances. The use of DRs should realistically be expected to spread only if it is accompanied by reliable internet connectivity throughout India. Thereafter, over time, the use of DRs could eventually spread within India and even to neighbouring countries such as Nepal and Bangladesh through coordination with authorities in these countries. The extension efforts of scheduled commercial banks and publicity provided by the central and state governments could help promote the use of DRs and reduce counterfeit cash-driven activities.
Taking a step back to reflect, it is likely that individuals or others who could learn to use DRs would probably have savings accounts in scheduled banks and know how to transfer funds between bank accounts. Such individuals and MSMEs may feel that there is no additional benefit to using DRs. Potential users may be wary about transactions being tracked even though it is claimed that the use of DRs does not leave any trail. Namely, that there could be ways for investigation agencies to track senders-receivers of large value DR transfers. In this context, it was evident from the huge amounts of cash deposited following the November 2016 demonetisation exercise that some individuals and small businesses prefer to use cash to remain anonymous and evade the goods and services tax or other tax liabilities. Unfortunately, far too many in India find highly inventive ways, usually with the assistance of chartered accountants, of remaining below the radar screens of investigative and tax authorities. Consequently, the RBI’s DR initiative is likely to be stillborn without complementary steps to reduce the use of cash.
Large cash transfers could be discouraged and the use of DRs promoted with the gradual withdrawal of all high denomination currency notes. For instance, all notes above INR 100 could be demonetised over, say, a three-year period. Thereafter, it would be difficult to transport large bundles of 100 rupee notes without being detected, given that the reach of remotely managed camera surveillance is being systematically widened. It is likely that there would be knock-on benefits such as a decrease in smuggling of subsidised fertilisers to neighbouring countries, which is probably paid for in large denomination cash notes. The claimed objectives of demonetisation could be achieved without disruptive consequences since DRs would provide an alternative for making large value cash equivalent payments. MSMEs and individuals who need to make or receive large cash payments would not be able to claim with any credibility why they must use cash when they could just as easily use DRs.firstname.lastname@example.org. The writer is a former Indian Ambassador, World Bank Treasury expert, and currently distinguished fellow at the Centre for Social and Economic Progress