Can the digital rupee dethrone cash? The future of India’s CBDC hinges on innovation

In a little over three years, the sand dollar has completely transformed the banking system in the island nation. Powered by blockchain technology and directly tied to the Bahamian dollar, it has successfully filled the void left by traditional banking systems in the Bahamas. With more than 100,000 registered wallets, which is roughly 25% of the Bahamian population, the sand dollar is a novel solution for promoting financial inclusion.

In contrast, the CBDC launched by the Reserve Bank of India, popularly known as the digital rupee (e₹), has faced a distinct set of challenges since its pilot over two years ago. Despite multiple efforts to promote its adoption, it has not yet achieved widespread use. As of March 31, 2024, the total value of digital currency in circulation was Rs 234.04 crore for retail transactions, compared to Rs 5.70 crore a year ago, according to RBI data (see chart). Although there has been some growth in retail digital rupee (e₹-R) transactions, its share is negligible (0.006%) in comparison to the total banknotes in circulation.

The Challenges

CBDC or digital rupee is a form of digital currency piloted in both wholesale and retail segments in India. It functions as legal tender, just like physical currency. While e₹-R comes in different denominations from 50 paise to Rs 2,000, wholesale CBDC (e₹-W) does not have specific denominations.

The pilot for e₹-W began in November 2022 to facilitate interbank call money trades, while the retail CBDC pilot was launched on December 1, 2022, initially covering select locations with a closed user group of customers and merchants. The retail CBDC pilot began with four banks in four cities and has since grown to 15 banks and 81 locations. To promote adoption, the central government introduced interoperability, allowing transactions through UPI QR codes. Despite these efforts, retail participation remains low compared to traditional currency.

Although there has been growth in retail digital rupee transactions, the wholesale segment has seen a decline. In March 2024, the value of the wholesale segment in circulation was just Rs 0.08 crore, a big decline from Rs 10 crore in March 2023. According to former finance secretary Subhash Chandra Garg, there was only limited interest in using digital currency, despite some initial encouragement in the first year for using the wholesale currency for government securities and settlement accounts. By the end of the second year, the wholesale segment had largely collapsed, reflected in the dwindling volume of transactions. Meanwhile, the retail digital rupee has seen a jump.

One major obstacle to the digital rupee’s success is the widespread use of the Unified Payments Interface (UPI), a cost-free and highly popular payments system. “CBDC was launched more as an experiment by central banks. Given the existing systems such as RTGS and UPI [here], it is difficult for a new concept to gain traction,” says Madan Sabnavis, Chief Economist at Bank of Baroda. “The convenience and widespread adoption of UPI makes it difficult for the digital rupee to offer additional benefits to retail customers,” he adds.

Another problem is the lack of convenience. The retail digital rupee supports only specific denominations; this limitation restricts users to making payments in the nearest available denomination.

Banks have also contributed to the sluggish adoption of the digital rupee. Experts point out that banks have not been promoting CBDC as actively as they should have done. The limited enthusiasm and support from financial institutions can impede the growth and acceptance.

UPI’s success can be largely attributed to significant marketing efforts and incentives like cashbacks, says Vijay Mani, Partner-Banking and Capital Markets Leader at Deloitte India. “This level of promotion may be hard to replicate for CBDC, as banks might be reluctant to spend heavily on marketing,” he adds.

Privacy concerns further complicate the adoption of the digital rupee. Unlike traditional cash transactions, digital currencies generate a comprehensive record of transactions that can be easily monitored and analysed. Ruchin Kumar, VP-South Asia at enterprise data security solutions provider Futurex, emphasises that this raises concerns about the handling and protection of personal financial data. “The ability to track transactions could lead to intrusive surveillance or misuse of sensitive information if not managed properly. Ensuring robust privacy protection while maintaining transparency and preventing illicit activities is a critical challenge for central banks,” says Kumar.

Future Prospects

The future success of the digital rupee depends on several factors, including its programmability and specific use cases. At a recent event, RBI Governor Shaktikanta Das spoke about programming the end use of funds such as for agricultural inputs, which could verify the identity of beneficiaries. Deloitte India’s Mani says, first, use cases that make digital payments truly native to online commerce need to be identified. “Second, develop compelling offline use cases, such as enabling transactions without internet connectivity. Third, leverage programmability in the public sector to ensure faster money delivery and control over spending, [thereby] preventing misuse,” says Mani. These features could secure a future for digital currency, though its full potential remains uncertain at this stage, he adds.

Offline functionality is critical to the digital rupee’s success. In order to ensure usability in areas with limited or no internet connectivity, RBI is planning to conduct tests on various offline solutions in different environments, such as rural and hilly regions. It intends to gradually introduce these offline features through pilot programmes.

In addition, RBI seems to be prioritising the expansion of digital rupee pilots by incorporating a range of use cases, exploring new designs, and involving more participants, as per its latest annual report. “RBI seems focussed on increasing use cases and design to expand the scope of ongoing pilots in e₹-R and e₹-W in 2024-25 by incorporating various use cases as well as new designs, technological considerations and more participants, besides launching a full-scale public tech platform with more financial institutions/data service providers and product offerings,” the annual report says.

Cross-border payments represent another growing use case for CBDCs. According to Shilpa Mankar Ahluwalia, Partner and Head of Fintech at law firm Shardul Amarchand Mangaldas & Co., cross-border payments pose significant challenges for SMEs and MSMEs, affecting their costs, timing, and overall complexity. CBDCs have the potential to address these issues by making payments faster and more efficient. However, this requires global central banks, including RBI, to coordinate and integrate their systems. If successful, CBDCs could replace traditional systems like SWIFT and improve both high-value and small-value cross-border transactions. Although the idea of CBDCs for international payments holds promise, there are still practical challenges that need to be addressed. Garg highlights issues such as exchange rates and currency acceptability that pose significant hurdles. “Technical barriers may be surmounted by using common (international) technical standards,” said RBI Governor Das about cross-border digital currency interoperability at the recent event.

Overall, e₹ faces several challenges, including competition from the existing systems and privacy concerns; however, it holds significant potential for improving financial transactions. By addressing these issues and enhancing its functionalities, e₹ could become a vital part of India’s financial landscape by 2047. 

@teena_kaushal