BharatCoin - India's Digital Currency - An Idea whose time has come

This was published in The Economic Times on the 25th of April 2018

Cryptocurrencies have captured the imagination of a section of investors globally. An idea with seductive appeal — cryptocurrencies (like Bitcoins) have gained both fame and notoriety, leading to a global regulatory weariness around them. The latest sceptic is the Reserve Bank of India, which recently banned regulated entities from dealing in cryptocurrencies in India. While commercial, private cryptos struggle with extreme price volatility and regulatory scepticism, there is another interesting concept being developed globally — one of Central Bank Digital Currency (CBDC). In a nutshell, can RBI issue a digital currency, lets call it the BharatCoin, just as it issues currency notes today? It’s an idea whose time has come, and there are some compelling reasons why RBI should consider issuing BharatCoins.

The most important application of BharatCoin would be to provide the general public an expansion in choice for a deposit account – it would be akin to an online-only, sovereign-risk bank account with a modern and cheap payment option. BharatCoin would provide safety of the sovereign like in currency notes (it would be a liability of RBI, in effect the Government of India, rather than a bank), likely provide an interest unlike currency notes today (which are zero interest-bearing instruments, and holders get no return for storing them in their wallets), would be cheaper than most electronic payment solutions today, and have the ability to transact anywhere and with anyone with access to a smartphone. At the same time, for RBI, it would be infinitely cheaper to issue BharatCoin in a digital format than to print, transport, safeguard and carry out forensics on counterfeits on currency notes today. The savings from this exercise would accrue to RBI, and by definition, to the taxpayer.

Second, BharatCoin could make the process of monetary policy transmission lot smoother and efficient. RBI influences monetary policy via changes in what is commonly called “policy rates”— these are rates at which RBI borrows from (or lends to) approved counterparties. However, the list of approved counterparties to RBI is quite small, consisting primarily of licensed banks. Therefore, the transmission of a rate cut (or hike) by RBI to the public (and corporations) at large is dependent on a small set of banks faithfully transmitting the same. For obvious reasons, this is often prone to issues, especially if the small set of counterparties collude with each other to minimise the transmission. It’s an issue that RBI has often raised concerns over. BharatCoin dramatically increases the number of approved counterparties to RBI —essentially anyone holding a BharatCoin is a counterparty — in effect millions of retail and corporates who hold BharatCoin instead of cash or bank deposits. If RBI (say) raises policy rates, and banks refuse to pass on the entire rate hike to depositors, millions of depositors would have an option to en masse swap their deposits for BharatCoins, thereby exerting competitive pressure on banks to follow suit quickly. A more efficient transmission of monetary policy would typically result in better all-round outcomes on economic development, as RBI can sharpen its interventions and minimise collateral impact.

Third, BharatCoin will enable the RBI potentially minimise the cost of government debt. The primary source of revenues for any central bank (including RBI) is issuance of currency notes. For every (say ₹100) note that RBI issues, it holds an equivalent amount of government bond in its balance sheet. As RBI pays no interest on a currency note, it makes the spread between the yield on the government bond it holds and the zero interest rate it pays on the currency note — in technical terms, called seigniorage. Earnings from seigniorage accrues to GOI, which is used for either tax-cuts or spends on various development activities. As the economy starts using less cash at the margin, there is potentially a risk to seigniorage revenues. BharatCoin issuance would be a potential hedge against such a possibility, as issuance of BharatCoins would be similar to that of currency notes, ie, against RBI holdings of government bonds, and accrue seigniorage revenues. In a recent paper on CBDC, Bank of England estimated a 3% boost to GDP on account of interest set-offs to government debt made possible via issuance of CBDC.

Last, but not the least, BharatCoin resolves an old monetary policy conundrum of “zero lower bound”. If RBI needs to reduce policy rates to negative levels in response to a severe slowdown, the existence of cash obstructs the slide below zero. With RBI policy rates at (say) -2% and currency notes yielding 0%, authorised counterparties like banks will convert their reserves with RBI en masse into cash until only the latter remains. At this point RBI would have lost its ability to reduce rates — cash doesn’t pay interest nor can it be penalised — and would no longer be capable of exercising monetary policy. This is the zero-lower bound.

BharatCoin can solve the problem. As it gains more acceptance among the general public in lieu of cash, RBI can cancel high denomination notes. Consequently, in a crisis situation, RBI would have the flexibility of taking policy rates down to negative levels. If authorised counterparties like banks wanted to convert RBI reserves into BharatCoin, the rates on the latter too can be brought down to similar negative levels. Sans high denomination currency notes, the option of converting to cash becomes impractical from a storage/security/warehousing perspective. In a nutshell, it gives greater flexibility to RBI to pursue unconventional monetary policies should the economic situation warrant. Not a situation that India faces in the immediate future, but given the experience of developed economies in the last few years, it provides a template to be prepared!

The flip side? It would be increased competition for banks on their most valuable franchise — retail deposits. Interestyielding BharatCoin would be everything that a bank deposit is, without the credit risk inherent in a bank, and transaction costs that are likely to be a fraction of what banks charge.

BharatCoin will not be a perfect substitute for cash, especially around the privacy features of the latter. However, it is a concept that bears immense promise – of disruption in financial markets and a sharper, better way of administering monetary policy.