How RBI’s design choices will affect the demand for e₹

The RBI’s chosen to issue the e₹ in same denominations as banknotes and coins in circulation. (Representative image)

From December 1, the Reserve Bank of India (RBI) has begun public pilots of the retail e₹ the digital avatar of the rupee. The RBI has created Rs 1.71 crore of e₹ and targets involving 50,000 merchants and customers in the first phase of the pilot.

At first blush, it seems not all that different from UPI — you can access and transact it through mobile phones, using wallets issued by banks. You can scan merchant QR codes for payment to merchants. However, the user experience and design of e₹ will be vastly different to other digital payment modes — and that is the result of the RBI’s design dilemma with the e₹.

The global interest in a central bank digital currency (CBDC) is driven by both opportunity and fear. Central banks around the world started fancying the CBDCs once cryptocurrencies gained traction. The underlying idea was to cherry pick the best features of cryptocurrencies (like finality of settlements), and infuse them into a sovereign-backed digital currency. Some central banks (such as the RBI) also believed that a CBDC can help reduce demand for cryptocurrencies. Besides, the CBDCs would still offer the usual benefit of digital payments — traceability and savings from the costs incurred in printing and distributing cash.

But the RBI has its task cut out with the e₹. It has to ensure that the e₹: (a) is similar to how the public understands legal tender; (b) complements existing digital payment systems (like UPI), yet stands out from them; and (c) assuages privacy concerns but retains some traceability. Simultaneously, it has to ensure that e₹ doesn’t turn the banking industry on its head. Now, striking a balance between these competing interests is hard. More so because these choices impact the adoption of e₹. The RBI’s made some hard calls (for the pilot) anyway.

For familiarity, the RBI’s chosen to issue the e₹ in same denominations as banknotes and coins in circulation. This, the RBI believes will lead to wider acceptance of e₹. But this also seems to be a downgrade (from UPI) in terms of user experience. Why limit the e₹ to denominations when digital payments offer infinite divisibility?

Privacy may also significantly impact adoption of e₹. Fundamentally, there are three truths to privacy in payments: (a) users do prefer some level of privacy. Cash offers them this; (b) no form of digital payment is entirely trail free; and (c) no one likes payments made for illegal activities. The RBI had mooted the idea of anonymity for small value transactions in its concept note on the CBDCs. But it did not comment on this in the e₹ pilot press release. Reportedly, the RBI is inclined to offer a greater level of anonymity for e₹ transactions (compared to the UPI), to increase adoption and is working on solutions to delete trail left by transactions between e₹ wallets but without compromising anti-money laundering safeguards. Both of those sit on opposite ends of a see-saw.

The RBI has decided to offer no interest on e₹ holdings (unlike bank deposits). Because if it did, users would prefer to park their funds as e₹ instead of bank deposits. That would threaten bank deposits, and in turn, credit creation by banks. This may drive up deposit rates and increase banks’ costs of funding, that will have to be absorbed by borrowers or managed through high-risk, high-return activities. One way to mitigate the risk of disintermediation of banks is to impose a cap or limit on individual holdings but the RBI notes that this will reduce acceptability of the CBDCs and introduce complexities.

On the other hand, would you choose to hold your funds as non-interest bearing e₹? Sure, e₹ offers cash-like safety since it is the liability of the central bank, and not of a commercial bank, but the nuance may be lost on retail users. Would enough users forego interest on their funds for this safety?

The RBI’s problem is that it can design a good e₹. But not the best. A tilt towards complete transaction traceability may deprive users of privacy. Avoiding disintermediation of banks may disincentivise adoption of the e₹. The e₹ will have some clear advantages when compared to cash (lower costs of minting) and existing digital payments (safer). But those advantages will be moot until India adopts it at large.

The RBI must critically examine these questions during its e₹ pilot, and make iterative design changes. So that India adopts the e₹, like it did the UPI.

Anirudh Rastogi is Founder and Managing Partner, Ikigai Law, and Priyam Jhudele is Associate, Ikigai Law. Views are personal, and do not represent the stand of this publication.