Modi government’s Rs 2,000 bet

The May 19 announcement by the Reserve Bank of India (RBI) regarding the withdrawal of Rs 2,000 banknotes from circulation has sparked discussions about potential demonetisation 2.0.

The conspiracy theories abound, and so do the theories about electoral politics. For decades, political analysts and observers have highlighted the trifecta of the ‘ABC’ — Alcohol, Biriyani, and Cash — in shaping electoral outcomes. These practices, aimed at wooing voters through short-term gratification, have perpetuated a culture of transactional politics. One such notable development was the introduction of electoral bonds, which aimed to replace conventional cash-based campaign funding. While this step was hailed as a positive move towards transparency, cynicism and scepticism persist unless tangible changes are observed in the ground realities of electoral campaigns in the upcoming 2024 national elections.

The obvious blind spot in these arguments for the RBI's decision on Rs 2,000, is the strides that India has achieved in digital economy, and the future of currency.

The Indian economy has made significant strides in embracing the digital revolution, with initiatives such as JAM (Jan Dhan, Aadhaar, Mobile), the revolution Reliance's Jio brought in Internet and data usage, and the development of a robust payments system. Even few years ago, the Indian consumers could not have imagined their transacting with smart phones and banking on apps, with ease and safety of transactions. Similar would be the disbelief for the rationale that we might move to digital currencies from paper ones.

With the rise of Central Bank Digital Currencies (CBDCs), the way we transact, store value, and conduct business is on the verge of a transformative change. As technology and
innovations in the financial sector’s technology-adoption continue to reshape Indian consumer behaviour, and data usage soars, it is natural for the RBI to consider the adoption of digital currencies.

This move would alleviate the costs and logistical challenges associated with traditional currency operations, such as printing, storage, transportation, and cash management. As cash in circulation and the overall economy increases, it will cost a lot more, for the traditional paper currency management for the RBI. A cost that could be saved, not only for financial purpose, but also with few strategic benefits.

CBDCs as a tool

The CBDCs represent a digital form of traditional currency issued and regulated by central banks. They offer the central banks a new set of policy levers to manage the economy effectively. By leveraging the CBDCs, the central banks can implement tiered interest rates, negative interest rates, and transmit changes in interest rates directly to the financial system and households. This enhanced control allows for a more precise and agile monetary policy response to economic conditions.

While the CBDCs offer transparency, traceability, and robust security measures, concerns about privacy and the availability of exact denominations persist. Unlike digital payment systems such as the UPI, the CBDCs require users to load different denominations, posing challenges when making precise payments or receiving change. Balancing privacy and security are crucial to ensure public trust in the digital currency ecosystem. Today, paper currencies offer anonymity to its users.

The CBDCs provide real-time transaction data that can revolutionise the way the central banks monitor and assess the economy. With access to detailed information about money aggregates such as M1, the central banks can make data-driven policy decisions, analyse spending patterns, and enhance the overall economic efficiency. The use of digital currencies eliminates intermediaries, streamlines cross-border transactions, and simplifies settlement processes.

Other positives

India's move towards the CBDCs aligns with its commitment to the Financial Action Task Force (FATF) and efforts to strengthen the financial sector. Enhancing the digital economy, utilising the CBDCs for monetary aggregates, and improving the traceability of currency ownership and movement can positively impact India's upcoming FATF review. The recent regulations bringing the financial sector stakeholders and auditors under the Prevention of Money Laundering Act (PMLA) was a commitment to the FATF. Moreover, from a political standpoint, transitioning to digital currencies can help reduce corruption and disrupt the traditional modes of electoral funding.

The withdrawal of Rs 2,000 notes is a significant step towards accelerating India's transition to a digital economy. By replacing paper currencies with digital alternatives and facilitating seamless integration with existing payment systems such as the UPI, the CBDCs might address the daily transactional needs of individuals and institutions alike.

This Rs 2,000 announcement might be the new road to higher-value denominations going digital, and not being used as paper currencies. Embracing a digital future promises greater financial inclusion, reduced costs, enhanced transparency, and improved settlement processes.

(Srinath Sridharan is an author, policy researcher, and corporate adviser. Twitter: @ssmumbai.)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.