The story so far: The Reserve Bank of India launched the digital rupee this week on a pilot basis. The digital currency will initially be offered by a select group of public and private banks in a few major cities, which can be used for both person-to-person and person-to-merchant transactions.

What is the digital rupee?

The digital rupee, or e-rupee, is a central bank digital currency issued by the RBI. It is similar to the physical cash you hold in your wallet, except the e-rupee is held electronically in an RBI-supervised digital wallet. The digital rupee is recognized as legal tender by the RBI and therefore must be accepted by everyone in the country as a medium of exchange. It is, however, different from the deposits you hold in a bank. Unlike remunerated deposits, the digital rupees in your wallet do not receive any interest from the central bank. Deposits held in banks can be converted into digital rupees and vice versa.

Do we need the digital rupee?

The RBI believes that the digital rupee will make the rupee more attractive as a currency for users compared to cryptocurrencies. Cryptocurrencies have been viewed by many investors as alternatives to fiat currencies which gradually lose value over time due to central bank downgrades. As such a trend could threaten their sovereignty, central banks have attempted to create their own digital currencies. The RBI also believes that the digital rupee will be easier and cheaper to produce compared to physical treasury notes. More importantly, transactions made using digital rupees, unlike physical transactions, are more easily traceable by authorities.

What are the risks ?

The introduction of central bank digital currencies internationally has worried many who believe it could disrupt the banking system. When the interest rates offered by banks are low, people may be more inclined to convert their bank deposits into digital currencies, as they would not lose much interest income by making the switch. Such an event could lead to a decline in bank liquidity and hamper the ability of banks to originate loans. It should be noted that the ability of banks to create loans is influenced by the amount of cash they hold in their coffers. Indeed, the cash position of a bank determines its ability to develop its loan portfolio while controlling the risk of bank runs. The digital rupee could also play a crucial role in India’s transition to a cashless society. An increase in the use of the digital rupee could eventually free banks from having to maintain sufficient cash deposits before expanding their loan portfolios. This could happen if digital rupee deposits are found to be seen as equivalent to other forms of virtual currency such as deposits initially created as loans by banks. In this case, banks will be freed from the risk of bank runs that have traditionally acted as a brake on the unbridled expansion of loan portfolios.

What are the critics saying?

Critics aren’t so keen on the idea of ​​a digital rupee. They point to the power that digital currencies give central banks to oversee economic activity and believe that this could have a chilling effect on economic growth if legitimate economic activities are deemed illegal by governments. The future of central bank digital currencies as an alternative to private cryptocurrencies might also be overstated. Private cryptocurrencies have found demand with some investors, not just because they are digital. Rather, they are believed to be better stores of value, displaying more stable purchasing power than fiat currencies.