INTRODUCTION
Cryptocurrency is a virtual or Digital currency. It is the outcome of consistent growth of information technology in the last three decades. The fear is expressed whether emergence of this digital currency would render Central Banks obsolete. The virtual currency may one day serve as alternative means of payment and unit of account. That would reduce demand for fiat currencies or Central Bank money. This paper has endeavoured to seek an answer to the question, “Will Monetary policy remain effective in a world without legal tender money?”
CRYPTOCURRENCY- ORIGIN AND GROWTH
The origin of cryptocurrency maybe related to the year 1883, when American Cryptographer David Chaun created cryptographic electronic money called as e-cash. However, it failed to attract the attention of the household and the business sectors for large scale application as medium of exchange and unit of account in day-to-day transactions in all types of markets.
Then on 18th August 2008, the domain name bitcoin.org was registered. In the same year, on 31st October a paper authored by Satoshi Nakamoto and titled as, ‘Bitcoin- A Peer to Peer Electronic Cash System’ was posted to cryptography mailing list. It was this paper which led down foundation of Bitcoin as major cryptocurrency. This paper explained various methods of using peer to peer network to create a system for electronic transactions. On 3rd January 2009, the Bitcoin network came into existence. Today Bitcoin has emerged as the most valuable cryptocurrency or e-money in the domestic and international monetary systems which are not regulated by either Central Banks or International Monetary Fund. Therefore, Bitcoin and other e-currencies which emerged in large proportion between 2009 and 2021 are considered alternative currencies or decentralized currencies.
There has been tremendous growth of the value of cryptocurrencies in relation to other fiat currencies in the cryptocurrency exchanges. This appreciation of value of cryptocurrency has become the cause of relatively more popularity of all cryptocurrencies than that of fiat currencies in the international monetary system. It is important to mention here that cryptocurrencies can be exchanged for fiat currencies in specially created online markets or cryptocurrency exchanges. So, each cryptocurrency has variable exchange rates, which indicate external values of these currencies in relation to other fiat currencies such as USD, British Pound and European Euro. One of the reasons for absolute increase in an external value of cryptocurrency is the scarcity of this currency in the online markets. This scarcity widens the gap between demand and supply of this currency. The demand is always greater than supply and external value appreciates consistently. As external value appreciates speculative demand for this currency increases with geometrical proportion and value appreciates unbelievably. This is virtuous circle of appreciation of value of cryptocurrency in relation to other Central Bank currencies. This is the secret of Bitcoin, being most valuable cryptocurrency today. As on 14th April 2021. Exchange rate of Bitcoin in relation to USD was USD 64,325.20 per unit of Bitcoin.
LEGALITY OF CRYPTOCURRENCY IN INDIA
Following is the summary of events developed in India in the context of legal acceptance of cryptocurrency.
• In 2018 Reserve Bank of India (RBI) banned financial institutions from dealing with cryptocurrencies
• In March 2020 the above decision was revoked after Supreme Court order, that allowed operations revolving around cryptocurrencies to restart in India.
• In February 2021, Government of India revealed that it would bring a new Bill on cryptocurrencies which would be referred to as Digital Currency Bill of 2021 in the ongoing Budget Session of Parliament. Finance Minister Nirmala Sitharaman has said that an Inter-Ministerial Committee (IMC) has suggested a ban on private cryptocurrencies like Bitcoin in India. Additionally, the same committee has asked for the introduction of an official digital currency which will be appropriately regulated by RBI.
• Now RBI has also clarified that it is working on a digital version of Rupee which may be referred as Central Bank Digital Currency (CBDC)
This paper therefore is directed to go into the details of present Monetary Policy of RBI in relation to fiat currency i.e., INR and then develop the hypothetical model of Monetary Policy of RBI in relation to proposed CBDC.
MONETARY POLICY OF RBI IN RELATION TO INR
RBI act of 1934 in its preamble sets out the objectives of the Central Bank as, ‘To regulate the issue of bank notes and keeping of reserves with a view to securing monetary stability in India and generally to operate the currency and credit system of the country in advantageous position’.
The above objectives of RBI, as mentioned in the preamble of RBI act 1934 have carved the path for monetary policy to be formulated by RBI as the Central Bank of India over a long period of time in independent India. Fundamentally therefore monetary policy of RBI is required to achieve dual goals of price stability and economic growth by regulating currency and credit system of Indian monetary economy.
In May 2016 the RBI act of 1934 was amended to provide statutory basis for the implementation of flexible inflation targeting framework. The amended RBI act provides for the inflation target to be set by the government of India in consultation with RBI once in every 5 years. Accordingly, the Government of India has notified in the official Gazette 4% consumer price index inflation target for the period from 5th August 2016 – 31st March 2021, with the upper tolerance limit of 6% and the lower tolerance limit of 2% for any three consecutive quarters. According to these tolerance limits, Monetary Policy of RBI is directed to stabilize average price level of all types of goods and services and thereby stabilize internal value of INR in Indian commodity markets.
Price stability is a necessary condition to achieve objective of economic growth. Monetary policy regulates issue of paper currency notes and distribution of bank credit among different productive sectors of Indian economy. This regulatory role of Monetary Policy is aimed at achieving balanced growth of Indian economy. The circulation of paper currency notes and bank credit in productive sectors enhances the productivity of these sectors. In other words, monetary policy generates the flow of capital towards all productive sectors and accelerates the production of all types of goods and services, which is reflected into an increase in Gross Domestic Product (GDP) of India every year. This is the approach of the monetary policy towards the goal of economic growth.
In reality Monetary Policy is required to achieve simultaneously the dual objectives of price stability and economic growth. For price stability the policy regulates quantity of paper currency notes and bank credit in such a manner that the flow of this quantity is more or less proportionate with the quantity of goods and services. For economy growth the policy regulates the distribution of this quantity among the productive sectors in such a manner that bank credit in particular is directed to increase productivity of these sectors. This regulation of quantity of paper currency notes and bank credit is with the support of quantitative (Bank Rate, Cash Reserve Ratio and Open Market Operations) and qualitative (Moral Suasion, Margin Requirement and Directives) instruments of the policy.
The above regulatory role of Monetary Policy of RBI indicates perfect control of the Central Bank over fiat currency or legal tender money, which is circulated in Indian Monetary System. Will the Central Bank be able to impose such a control, of similar magnitude over digital currency? This is examined below.
MONETARY POLICY IN RELATION TO DIGITAL CURRENCY
IMF paper published on 21st December 2020 (Rakesh Sharma) has attempted to explore an answer to the question, ‘Will dominance of USD as paper currency be threatened by the digital USD, created by Federal Reserve Bank of America’? At present 61% of global reserves consist of USD as paper currency with all the Central Banks in the global economy. According to this IMF paper digital USD may become as powerful as its fiat equivalent.
It is on the above background that in the following analysis attempt is made to examine whether CBDC created by RBI will strengthen Indian paper currency (INR) in international financial market. If this happens, experiment of issuing digital Rupee will be more favourable to Indian eco-system.
We may examine the role of Monetary Policy of RBI in relation to the digital currency under following assumptions.
- RBI is assigned the monopoly position to create and circulate cryptocurrency in Indian Monetary System.
- Legalized cryptocurrency created by RBI is denoted as Central Bank Digital Currency (CBDC)
Based upon the above assumptions we may observe how RBI will create and circulate CBDC in Indian and International monetary systems.
CBDC IN INDIAN MONETARY SYSTEM
To understand the role of Monetary Policy of RBI in issuing CBDC as new currency in Indian Monetary System, we may classify CBDC into following categories.
• Wholesale CBDC
• Retail CBDC
Wholesale CBDC –
It will be circulated among the commercial banks and non-bank financial institutions against the deposits of cash reserves with RBI. The financial institutions will receive CBDC in proportion to their cash reserves with RBI. It means that value-based wholesale CBDC will replace cash reserves. This wholesale CBDC will be the digital token issued by the Central Bank. The token will be a bearer asset which will be used for transactions. During these transactions sender will transfer value to the receiver without any intermediary. This will be fundamentally different from the present monetary system in which the Central Bank debits and credits the accounts without transferring actual values. The wholesale CBDC can become most popular proposal among all the Central Banks because it has potentials to make wholesale financial system faster, inexpensive and safer. The Bank of International Settlement has also supported this view.
Retail CBDC –
Retail CBDC is one that will be issued for general public. Retail CBDC, based on digital transaction has features of anonymity, traceability, availability 24 hours a day and 365 days a year and feasibility of an interest rate application.
Retail CBDC will be issued by RBI and it will be made available to general public through commercial banking system. Therefore, RBI will be able to manage and regulate circulation of Retail CBDC with effective monetary policy. If Digital Currency Bill of 2021 is transformed into Digital Currency Act, retail CBDC issued by RBI to general public will develop features such as acceptability as mode of payment, legal tender and store of value for household, business and government sectors. It may be pointed out that acceptability of retail CBDC can be intensified if this CBDC is distributed at one-to-one parity with fiat currency (INR) in India. It is also necessary that CBDC distributed by RBI should be freely convertible into commercial bank money and cash. It will accelerate the process of merging of digital currency in Indian Monetary System. As soon as CBDC is distributed at a retail level, RBI has to develop technology framework, such that there should not be a need to maintain bank account for obtaining CBDC.
CBDC IN INTERNATIONAL MONETARY SYSTEM
Once CBDC is circulated at wholesale and retail levels an instant international payment and settlement would become reality and then CBDC would be most attractive e-money in Indian monetary system.
Entry of e-Rupee or Indian CBDC in international monetary system will depend upon the confidence of Indian and International community in Indian Digital Currency. RBI will have to inculcate this confidence by stabilizing and appreciating external value of this currency. Supply side of this currency will be managed by RBI, while demand side maybe largely influenced by export transactions and inflow of foreign investment in India. The exporters may demand CBDC in exchange for their foreign exchange earnings. The foreign investors in India may also demand CBDC in exchange for their foreign capital for transactions in Indian financial markets and physical asset market. The commercial banks as authorized dealers in foreign exchange market will have to offer CBDC to the exporters in exchange for their foreign exchange earnings and to the foreign investors in exchange for their foreign capital.
If RBI manages to keep supply marginally lower than demand for CBDC, value of CBDC can be stabilized in such a manner that marginally rising trend in this value is developed for a long period of time. If Monetary Policy is effective in generating this trend in the value of CBDC, the confidence of Indian and International community in Indian CBDC will be boosted considerably and that will lay down foundation for emergence of Indian CBDC as a strong digital currency in the digitally operated international monetary system.
If the above possibility becomes reality, Indian e-currency will become valuable currency in International Financial Markets. Speculative demand for this currency will increase and there will be further acceleration of value of this digital currency. In the digital currency war, that may emerge in the digitally operated international monetary system Indian CBDC may become conspicuous digital currency. The foreign institutional investors and International speculators may be willing to exchange relatively more amount of digital foreign currencies such as USD and EURO to purchase Indian CBDC. This will create positive impact on the foreign exchange reserves of India. Then this official cryptocurrency will become boon for Indian economy.
CONCLUSION
From the above analysis it may be generalized that the Central Bank must play a pivotal role, guaranteeing the stability of the value of digital currency and over-seeing the overall security of the digital monetary system. In this context following argument of Milton Friedman is very relevant to the role of the Central Bank and the government in consolidating the monetary system of e-currency.
‘Something like a moderately stable monetary framework seems an essential pre-requisite for the effective operation of a private market economy. It is dubious that the market can by itself provide such a framework. Hence the function of providing one is an essential governmental function on a par-width the provision of a stable legal framework’.
About the Author
Abhibhav Dujodwala is 16 year old student of Cathedral & John Connon School School in Mumbai having a passion for the world of Finance,Economics and the way both complement each other.
NOTE: The views expressed here are those of the authors and do not necessarily represent or reflect the views of New Delhi Times (NDT)
Photo Credit : https://en.wikipedia.org/wiki/Cryptocurrency
