Why the financial sector in India is shrugging at the digital rupee

Written by Kapronasia || January 16 2023

India launched its long-awaited CBDC pilot in early November – wholesale – and early December – retail – with much fanfare. Nine banks are participating in the wholesale pilot and four in the retail pilot, which is focusing on the cities of Mumbai, New Delhi, Bengaluru and Bhubaneswar.

Banks are distributing the digital rupee through digital wallets on mobile phones. Both person-to-person transactions and consumer to merchant payments are possible, the latter requiring the scanning of a QR code.

Despite the high hopes of the Reserve Bank of India (RBI) for the digital rupee, the reaction from the subcontinent’s financial industry thus far has been muted. While this may surprise regulators, who seem to see a CBDC as a silver bullet that can do everything from discourage use of crypto for payments to boost financial inclusion to reduce the cost of transactions, it is not surprising to anyone aware of the limitations of the digital rupee in its nascent incarnation – and the strengths of India’s existing digital financial ecosystem.

A solution in search of a problem

The RBI reckons the digital rupee can be a viable alternative to cash, boasting distributed ledger technology: fast, efficient, offering some anonymity, and of course, state-of-the-art. It sounds nice in theory, but thus far – as is often the case with blockchain – the e-rupee looks like a solution in search of a problem.

India has already made significant progress reducing cash use with digitization of its existing fiat currency. In fact, India made 48.6 billion real-time B2B payments in 2021, the most in the world and 40% of the global total, research by ACI Worldwide, GlobalData, and the UK’s Centre for Economics and Business Research (CEBR) shows.

Bankers participating in the wholesale e-rupee pilot interviewed by Reuters said that they have not seen any benefits from use of the CBDC. They emphasized that using it as similar to India’s existing internet-based banking with which users are already satisfied.

As it turns out, thus far the digital rupee has a few drawbacks compared to fiat currency. On the one hand, each trade using it has to be settled individually. In contrast, trades in the traditional inter-bank payment system are first netted off and then settled in bulk with the clearing corporation. Further, since digital rupee transactions do not wholly replace those using established procedures, they create more accounting work for banks.

As for the retail pilot, we wonder how the digital rupee will compete viably with India’s dominant consumer real-time payments system United Payments Interface (UPI). UPI is fast, convenient and offers some anonymity as it lets users transfer money between banks without disclosing account details. It also links up with the most popular e-wallets in India: Google Pay, PhonePe and Paytm.

UPI processed a record 7.82 billion transactions in December, amounting to Rs 12.82 trillion, also a record high. On an annual basis in December, transaction volume rose 71% while value increased 55%.

Crypto vanquisher

The RBI undoubtedly knows that the digital rupee faces certain obstacles. Yet the regulator will almost certainly push on with a digital fiat currency not only for its modest efficiency and financial inclusion benefits at some point in the future, but also to re-enforce the sovereignty of the central bank over monetary policy.

The RBI made explicit in its October concept note about the e-rupee that it sees cryptocurrency as a serious threat to the integrity and stability of India’s financial system because it operates in a murky, decentralized space. In the RBI’s view, this foments money laundering and other financial crime risks, while threatening the central bank’s exclusive right to issue currency. With that in mind, “it is the responsibility of central bank to provide its citizens with a risk-free central bank digital money which will provide the users the same experience of dealing in currency in digital form, without any risks associated with private cryptocurrencies,” the concept note says.

It is possible to argue that the RBI’s fears are misplaced, given that most Indians want to use crypto for investment purposes – they see it as an asset class – rather than for payments. Nevertheless, the Indian central bank may want to roll out the digital rupee to preempt the use of any type of decentralized digital currency for payments in India’s financial system – including stablecoins, which are now being touted by crypto evangelists as the responsible and foolproof crypto payment method.

RBI deputy governor T Rabi Sankar expressed skepticism about stablecoins last June at International Monetary Fund event, adding that he thought CBDCs could “kill whatever little case that could be made for private cryptocurrencies.”

Learning from the e-CNY

Looking ahead, the RBI may want to observe the development of China’s digital renminbi and assess whether there are any important takeaways applicable to the digital rupee. After all, China’s digital currency is the most advanced of any country globally.

To be sure, given the differences between the two countries’ political systems and economies, the RBI has less ability to mandate financial institutions and individuals use its CBDC than China does. If the RBI wants to see widespread e-rupee adoption, it probably will have to coax and cajole banks.

"I don't think once the pilot is concluded, without any RBI pressure, banks will want to use it," one banker told Reuters.

Still, perhaps the RBI can consider the importance of the digital rupee’s interoperability for retail payments. If the Indian CBDC is siloed in its own ecosystem, it will be less attractive than if it is interoperable with the dominant existing digital rails like UPI.

In this endeavor, China’s experience could be instructive. The dominance of both Alipay and WeChat Pay in digital payments is such that the e-CNY can only reach a certain level of user penetration without seamless interoperability with them. There were reportedly 261 million users of the e-CNY in January 2022 – the last time the Chinese government did a tally. Meanwhile, Alipay has about 1.3 billion users, while WeChat Pay has 900 million monthly active users.

And when it comes to innovation, the e-CNY is far behind the digital payment incumbents. Case in point: Ahead of the Lunar New Year, the dedicated wallet for the e-CNY has introduced a feature to send an electronic red envelope (red envelopes stuffed with cash are traditional gifts during the holiday). Alipay pioneered this concept more than a decade ago, while in 2014, WeChat Pay teamed up with the Spring Festival GalaGALA -0.2% to launch the WeChat red envelope shake.

We expect that the digital rupee could be even more of a laggard than the e-CNY without attractive incentives from the Indian government for both retail and wholesale users.