Decoding India’s Digital Rupee: A Deep Dive into CBDC Pilots and the Future of Finance

India is stepping into the future of finance with its Central Bank Digital Currency (CBDC), aptly named the Digital Rupee. Imagine a digital form of our familiar Rupee notes, issued by the Reserve Bank of India (RBI) – that’s essentially what a CBDC is. Last year, India embarked on pilot projects for both wholesale and retail CBDCs, signaling a significant move towards modernizing its financial infrastructure. But what exactly is happening with India’s Digital Rupee, and what does it mean for you and the nation’s economy? Let’s dive in and unpack this exciting development.

What’s the Buzz About India’s CBDC?

The Reserve Bank of India (RBI) has ambitious plans for its Digital Rupee, aiming for nationwide implementation as early as 2023. However, like any pioneering project, the journey hasn’t been without its bumps. Initial reports suggest that the pilot programs have faced certain hurdles, but the RBI remains committed to its vision. To understand the current status, let’s break down the two key pilot initiatives launched last year:

• Wholesale CBDC (CBDC-W): Launched on November 1st, this pilot involved nine major banks. It focuses on streamlining interbank transactions and making financial operations more efficient for institutions.
• Retail CBDC (CBDC-R): Kicked off on December 1st, this pilot brought the Digital Rupee to the public in select cities – Mumbai, New Delhi, Bengaluru, and Bhubaneswar. Four prominent banks, including State Bank of India, ICICI Bank, Yes Bank, and IDFC First Bank, participated in this initial phase.

The reach of the retail CBDC pilot is expanding. According to a top official, it has now extended to 15 locations, with Chandigarh being the latest addition. The adoption rate is also promising, with over 50,000 consumers and 10,000 merchants, including retail giant Reliance Retail, already onboarded.

Who is Using the Digital Rupee?

The current landscape of India’s CBDC pilots is segmented by user type:

While the government initially indicated a broader rollout of CBDC-R in 2022-23, the exact timeline remains somewhat fluid. It’s clear, however, that India is serious about integrating digital currency into its financial ecosystem.

India in the Global CBDC Race

India is not alone in exploring the potential of CBDCs. Globally, the concept is gaining significant traction. The Atlantic Council’s Central Bank Digital Currency Tracker reveals that a staggering 105 countries, representing 95% of the world’s GDP, are actively researching CBDCs. This global interest underscores the transformative potential of digital currencies in reshaping international finance.

The Bank for International Settlements (BIS) is playing a crucial role in facilitating this global exploration, assisting various governments in understanding and implementing CBDC use cases. Several international collaborations are already underway:

• Cross-border Retail and Remittance: Central banks in Israel, Norway, and Sweden are examining how CBDCs can streamline international retail payments and remittances.
• Project mBridge: A collaborative effort involving China, Thailand, Hong Kong, and the UAE, focusing on cross-border CBDC payments.
• Project Dunbar: Previously involving Australia, Malaysia, Singapore, and South Africa, exploring shared platforms for cross-border payments using CBDCs.

While India hasn’t yet joined a specific multinational CBDC project, it’s actively considering international collaboration. A central bank document suggests exploring partnerships with organizations like BIS to establish common global standards for seamless cross-border transactions. This indicates India’s ambition to not only adopt CBDCs domestically but also contribute to shaping the future of international digital finance.

Geopolitics and the Digital Rupee: What’s the Connection?

India’s interest in CBDCs goes beyond just technological advancement; it’s also intertwined with geopolitical strategy. While publicly, the RBI emphasizes the benefits of CBDCs as a simpler, faster, and cheaper payment alternative, there’s a deeper, strategic motive at play.

Privately, India aims to counter the dollarization of the global economy. As a rapidly growing nation with a massive population and the world’s fifth-largest GDP, India sees the Digital Rupee as a tool to enhance the international standing of its currency. As a CBDC official stated, “In the context of the internationalization of the Indian rupee, an Indian CBDC will make it simpler for the nation to acquire worldwide acceptability since it is digital… For emerging markets, it is a useful weapon to have for future internationalization.”

Navigating Public Perception and Understanding

One of the key challenges for India’s CBDC initiative is public awareness and understanding. There’s considerable debate and sometimes confusion among Indians regarding CBDCs, digital rupees, eRupees, and even the underlying blockchain technology. Even prominent figures like Infosys co-founder Nandan Nilekani have raised questions about the specific policy objectives of India’s CBDC.

The RBI has stated that the CBDC aims to “modernize the present physical (cash) currency system.” However, the exact implications of this modernization are not yet widely understood by the public. To address this, the Indian government has initiated “awareness” campaigns, primarily focusing on contrasting CBDCs with the risks associated with investing in cryptocurrencies. Government-run and corporate media outlets have also increased their coverage of CBDCs and their potential role in the Indian economy, a shift from previous promotion of crypto exchanges.

This shift in media focus might be partly attributed to the Advertising Council of India’s guidelines, which now require crypto advertisements to include disclaimers highlighting the “extremely dangerous” and unregulated nature of crypto products. As one official working on CBDCs noted, there’s a clear “pushing for education surrounding CBDCs.” The rapid launch of the pilot programs has also caught many media and financial experts by surprise, leading to increased discussion and analysis.

CBDC vs. UPI: Understanding the Differences

India has already witnessed a digital payment revolution with the Unified Payments Interface (UPI). UPI allows seamless transactions via QR codes linked to bank accounts, enabling instant money transfers. Given UPI’s success, many wonder – why do we need a CBDC?

RBI Governor Shaktikanta Das explains that a CBDC eliminates the need for a bank as an intermediary in transactions. While UPI transactions are facilitated by banks, a CBDC is essentially central bank money. As a CBDC advocate points out, “This is central bank money. This will offer all the benefits of actual cash without the hazards. This is a monetary system, not a payments system like UPI.”

Here’s a table highlighting the key differences:

Cash, while convenient, has drawbacks like ease of handling illicit activities (money laundering, counterfeiting). CBDCs aim to offer the benefits of cash, including a degree of anonymity, without these risks. RBI Deputy Governor T. Rabi Sankar highlighted that unlike UPI, CBDC can provide cash-like anonymity, stating, “How things evolve will determine what happens… However, money requires anonymity. It differs from UPI, which has a digital trail and is not anonymous.”

Financial Inclusion and Cost Efficiency

The RBI’s whitepaper on CBDCs emphasizes “fostering financial inclusion” as a primary motive. However, the current CBDC pilot requires users to have bank accounts. To participate, banks in pilot locations need to create digital wallets for customers, allowing them to transfer funds from their bank accounts into these wallets to conduct CBDC transactions. While RBI records transactions, this system, according to a CBDC spokesperson, aims to streamline payments by eliminating bank settlements.

There’s ongoing discussion about whether CBDCs can truly bank the unbanked. While one official suggested that CBDCs might not necessarily require a bank account in the future, this aspect is still under consideration and may vary across different pilot programs. For individuals without bank accounts, UPI remains inaccessible. However, there’s potential for RBI-authorized entities to open rural digital wallets with KYC checks, potentially bypassing the need for traditional bank accounts, depending on the specific pilot design.

Another aspect is cost efficiency. The RBI believes CBDCs can “dramatically” reduce operational costs associated with managing physical currency. While UPI has significantly boosted digital payments in India, its operational costs are substantial, estimated to potentially exceed 8400 crores INR ($1 billion) annually. The Payments Council of India estimates yearly losses of $664 million related to digital payments. The government hopes that savings from reduced cash usage will offset these costs. Currently, printing and managing currency costs India around $600 million annually. Given that cash still constitutes a significant portion (14%) of India’s $3.18 trillion GDP, there’s a considerable opportunity for cost reduction.

However, some argue that the potential cost savings might not outweigh the investment in CBDC infrastructure. The central bank would bear the financial responsibility of managing millions of digital vaults for Indian citizens.

CBDC and UPI: Competition or Coexistence?

While UPI has been a resounding success, there’s debate about the future relationship between UPI and CBDC. A senior CBDC official clarified that the RBI does not “envisage a picture without UPI.” Instead, CBDC is seen as potentially complementing or even eventually replacing cash, while UPI could continue to thrive based on user preference. The official suggested a competitive approach: “They appear to compliment each other. CBDC will seek cash. UPI can be rejected if comfort grows. Let it compete.”

Whether the government will actively incentivize CBDC adoption, especially given UPI’s popularity, remains to be seen.

Blockchain and the Technology Behind Digital Rupee

Finance Minister Pankaj Chaudhary mentioned to parliament that the CBDC pilot utilizes blockchain technology. However, a senior official described the technology as “half DLT and part API,” indicating a hybrid approach. They emphasized that the technology is still being tested, and various options are being evaluated to best serve India’s needs. The API component suggests that the current system isn’t entirely blockchain-based, leading to some ambiguity about the extent of blockchain integration in India’s CBDC.

The official explained that the current pilot is a “closed user group” aimed at rigorously testing the technology and all aspects of CBDC operation, from creation to usage. The system is reported to be functioning well and is expected to gradually expand to more cities and users.

CBDC as a Safe Alternative to Crypto?

The crypto sector envisions cryptocurrencies as a medium for buying and selling goods and services. However, recent events like the collapses of Terra, Three Arrows Capital, and FTX have highlighted the inherent risks and volatility within the crypto market. Central banks view CBDCs as a way to offer the public access to the benefits of digital currency without the risks associated with private virtual currencies and the broader crypto ecosystem.

Programmability and Future Applications

The full scope of CBDC applications is still unfolding. However, one intriguing possibility is programmability. A CBDC official mentioned that retail CBDC could be programmed for specific use cases. For instance, government subsidy tokens could be designed to be used only for designated project items. This opens up possibilities for targeted welfare programs and increased control over fund usage.

The RBI is also exploring offline payment capabilities and programmability features for the Digital Rupee. The goal is to leverage these experiments to develop the most robust and feature-rich CBDC tailored to India’s unique needs.

CBDCs: More Than Just Technology – A Geopolitical Tool?

Beyond technological modernization, both the central bank and the government see strategic advantages in India adopting CBDCs, particularly in a geopolitical context. CBDCs are increasingly viewed as potential geopolitical tools that could reshape the global financial landscape and offer nations a competitive edge. China’s aggressive pursuit of CBDC development is a significant factor in this global discourse, raising concerns and discussions extensively explored by institutions like Oxford University and Deutsche Bank. Even former U.S. officials have conducted “war game scenarios” to analyze the potential geopolitical impact of a Chinese CBDC.

This geopolitical dimension is reflected in the widespread global interest in CBDCs. Currently, 16 out of the 19 G-20 countries are actively developing or piloting their own CBDCs.

India, holding the G-20 presidency since December 1, 2022, is actively promoting global crypto regulation and leveraging elements of the CBDC framework in these discussions. According to a government official, the RBI’s G-20 team has been actively engaged in numerous meetings to foster international cooperation in this domain.

Cross-Border Payments and Remittances: A Key Focus

The impact of CBDCs on cross-border payments is another crucial area of exploration. Sources indicate that India is actively promoting CBDC collaboration in the context of foreign remittances during its G-20 presidency. The RBI believes that CBDCs have the potential to significantly reduce the costs, increase the speed and transparency, and improve access to foreign remittances for Indians. Remittances to India are substantial, with the World Bank reporting inflows of $100 billion in 2022.

The RBI’s concept paper emphasizes the importance of incorporating cross-border considerations into CBDC architecture from the outset and fostering international cooperation. This collaboration is crucial to address challenges related to time zones, exchange rate fluctuations, and diverse legal and regulatory frameworks across jurisdictions.

Looking Ahead: Security and the Future of Digital Rupee

In its communication, India has stressed that “security needs to be the key design consideration while creating CBDCs.” While committed to launching the Digital Rupee, India is proceeding cautiously, prioritizing security and robust testing. The journey of India’s Digital Rupee is still in its early stages, but it holds immense potential to transform the nation’s financial landscape, enhance its global economic standing, and potentially reshape international finance in the years to come.