The ongoing pilot project of the Central Bank Digital Currency (CBDC), also known as the digital rupee, has spurred a nationwide debate due to curiosity over its nature and use-functions. Already, India’s digital sphere is saturated by the NPCI’s Unified Payment Interface (UPI) (14.9 billion transactions in August 2024), and other digital platforms such as NEFT, RTGS, IMPS etc. So, it is not surprising that there is chatter over where the digital rupee fits in the digital economy.

To followers of international trends, it is clear that the move towards a digital rupee is not a choice. Per the International Monetary Fund (IMF), over 130 countries have begun to explore CBDCs, with 19 of the G20 nations in advanced stages of development. A recent report by the Bank of International Settlements (BIS) has also envisioned a ‘finternet’ using CBDCs as one plank to make financial transactions faster, seamless, and cost-efficient.

As the world’s fifth-largest economy, and a bridge between the Global North and South, it is crucial for India to lead in digital innovation.

A powerful implication of the digital rupee is its potential to combat tax evasion. CBDCs would help to dilute the shadow economy (20 per cent of GDP, World Bank) by making every transaction traceable, preventing income concealment.

Working in lockstep with other reforms like Goods and Services Tax (GST), the digital rupee can deepen and widen the tax base from its present 11.6 per cent of GDP.

A report of the National Institute of Public Finance and Policy (NIPFP) agrees, suggesting that improved transparency could increase India’s tax-to-GDP ratio by 4 per cent, leading to more revenues for social welfare and development.

Efficiency for businesses

Thirty per cent of GDP comes from micro, small, and medium enterprises (MSMEs). The digital rupee would reduce the friction of cash handling, leading to faster and cheaper transactions. This smoothening of inefficiencies of traditional payment systems due to CBDCs could even spur global GDP growth by 1.4 per cent (McKinsey).

This means, shopkeepers in rural India needn’t deposit cash every day. They can make real-time settlements using the digital rupee. This would reduce operating costs, leading to better prices for consumers and higher profits for business owners.

Financial Inclusion

Over 190 million adults are still outside the ambit of banking services in India (Global Findex 2021). The digital rupee can help to address this, as seen in the sand dollar of Bahamas and the e-CNY of China. By linking digital wallets to CBDCs and making government payments more efficient, both the countries were able to better include weaker sections and directly provide welfare.

Likewise, in India, digital rupee can make direct benefit transfer (DBT) of welfare benefits real-time and transparent. It can also support emergency responses, like disaster relief payments, by transferring funds directly to beneficiaries’ wallets.

An issue with cross-border payments is that traditional methods of settlement are unwieldy and rely on a few currencies such as the dollar. Hence, emerging market economies must stockpile reserves of these currencies to settle cross-border payments.

The BIS has recognised this as well, with its recent ‘mBridge’ initiative. Involving the use of multiple CBDCs and working with central banks from Thailand, Hong Kong, China, and the UAE, it aims to create a payment ecosystem for real-time, blockchain-based settlement of cross-border payments.

Given that India has signalled its intention to assist emerging market economies in reforming global payment systems, the digital rupee can be a boon. A globalised digital rupee could enhance India’s global trade, reduce transaction costs, and improve the clout of its currency.

The challenges

Thus, the development of India’s CBDC is a matter of highest importance. Even so, there are certain challenges to be addressed. A survey by LocalCircles found that over 60 per cent of Indian internet users are concerned about financial data being shared to third parties.

China has opted for a controversial model termed as ‘Controllable Anonymity’ to manage CBDC transactions. However, India will have to come up with a more robust approach to preserve the privacy of individuals while monitoring CBDCs for financial crimes and tax administration.

Digital divide and inconsistent internet connectivity are other issues, even as smartphone penetration in India has risen to 76 per cent (Pew Research, 2022). Both the e-CNY and the sand dollar allow offline transactions which is a feature that India can also consider.

As India digitises its currency, the threat of cyberattacks looms large with a 15 per cent increase in cybercrimes (NCRB, 2022). Blockchain based technologies are relatively resilient towards conventional cyberattacks. However, in a burgeoning ecosystem such as a digital currency, the RBI and other regulators must focus on building a secure, resilient cyber architecture.

The RBI’s regulatory sandbox, sectoral Computer Emergency Response Teams (CERTs), and timely exchange of information between regulators can beef up cybersecurity before the launch of the digital rupee.

Innovation by fintech companies and banks will also be needed. The success of the UPI was primarily due to fast adoption by a number of banks and financial start-ups. Integration of their financial products on top of the NPCI’s framework led to the vibrant ecosystem we see today. Likewise, the digital rupee will only go as far as the efforts of the private sector to encourage its usage. Expected to reach a market size of $150 billion by 2025 (NASSCOM), the fintech sector will have to be leveraged for the digital rupee’s success.

The path forward

The digital rupee offers India a unique opportunity to modernise its economy, enhance financial inclusion, and boost tax revenues. However, its success will hinge on addressing privacy concerns, bridging the digital divide, and fortifying cybersecurity. By drawing on the lessons from other countries and fostering collaboration between public and private sectors, India can unlock the full potential of this digital revolution.

Sood is Deputy Director, Ministry of Finance, and Kumar is an Indian Revenue Service officer. Views are personal