The writer is a former governor of the Reserve Bank of India
The Fed is ambivalent about digitising the dollar, or so it seems from the discussion paper it released last week. Australia remains sceptical about the benefits of a retail central bank digital currency. Although a first mover in the CBDC field, Sweden’s Riksbank is still in the exploration phase. By current indications, a “Britcoin” by the UK is unlikely before 2025.
This deliberative stance stands in contrast to the urgency with which scores of emerging economies are approaching CBDCs. About half a dozen have already issued official digital currencies — the Bahamas with its Sand Dollar being the first. China is vigorously testing its e-CNY in several regions. The much anticipated cryptocurrency bill to be introduced in India’s parliament shortly is expected to provide the legal framework for launching an e-rupee.
Advanced and emerging economies see the case for CBDCs differently. While the former are not yet persuaded that benefits outweigh risks, the latter seem to be driven by both fear and opportunity. Their biggest worry is that private cryptocurrencies will impair their own monetary sovereignty by displacing fiat money. This was not a big concern with bitcoin and its early rivals — despite their creators’ libertarian fervour to break the bonds of official currencies, they have so far failed to do so.
The story could be quite different with stablecoins, backed one-to-one by reserve assets such as the dollar or the euro. These currencies have the potential to pull transactions away from the domestic banking network and into their own ecosystems, thereby pushing central banks out of the loop on economic activity. A central bank’s ability to set interest rates, control money supply and manage inflation would be threatened.
How credible is that threat? With huge technology platforms planning to launch their own stablecoins along with an enticing suite of services for their billions of clients, the substitution of domestic currencies by transnational digital currencies is no longer just possible. It is probable. Many of these stablecoins are likely to be pegged to the dollar. Far from regulating them, the US might actually see in this an opportunity to extend the reach of the world’s dominant reserve currency. What is to prevent stablecoins, operating beyond regulatory gaze, to delink from the reserve peg, become independent creators of money and undermine domestic policy?
Emerging markets also fear the growing dependence of their populations on private payment systems. Central banks worry that hacking or outage of these systems could undermine the integrity of their currencies. CBDCs offer a way of providing a fail-safe centralised alternative. Fear apart, EMs also see several opportunities in CBDCs — the promise of reducing the cost of cross-border and domestic payments, deepening financial inclusion, checking counterfeiting and saving on the expense of printing and distributing currency.
There are, however, some ticklish challenges. The first is the possibility of “bank disintermediation”, which can happen if people shift their risk-carrying deposits in commercial banks to risk-free CBDC accounts. That will raise the cost of deposits and hence the cost of credit — a disturbing prospect at a time when EM growth is increasingly credit driven. Thankfully, however, that is not insurmountable and can be mitigated by capping both the amount people can hold as CBDCs and the interest the central bank can offer.
A bigger challenge relates to privacy: CBDC transactions, unlike cash, leave a trail. No matter that this will deter illegal activity; even honest individuals might feel queasy about the state being able to spy on their financial transactions. Robust data protection laws that inspire public confidence are therefore imperative.
Given that, the dictum for emerging markets as they move on launching CBDCs should be the Latin proverb festina lente: “make haste slowly”.