Recommendations On Central Bank Digital Currency (CBDC) And Inflation

The current news indicates that RBI has released the Central Bank Digital Currency (CBDC) system which is on a pilot project in the intra-bank transaction settlements between nine banks in India. And this will evolve with real-time learning experiences, in retail transactions for MSME businesses also. This is expected to commence as early as the end of November 2022 according to a leading media broadcasting house. However, the following are the recommendations for CBDC e-digital currency according to the Planned and Organised Deficit Spending (PODS) book research team. 

Digital vs Cash Transactions

Given that all the transactions in the economy are happening in cash, for CBDC to become acceptable, we need to incentivize digital transactions. For every unit of a digital currency issued, there should be a physical supply of goods, services, or agro. Such responsible issuance is expected to keep inflation in check. Furthermore, because of the equal demand-supply distribution of digital currency, we do not require the concepts of the velocity of money or the multiplier of money. As one monetary unit will produce one physical unit of matching supply. Until such demand-supply matches take place, money can be continuously digitally issued.

Money multiplier effect

All the tools are given by monetarists to control inflation i.e., CRR, SLR, REPO Rate, and Reverse repo rate are of no use in digital transactions. Because the time lag between issue and circulation is a matter of seconds and thus we do not need this. Digital currency could even nullify overnight lending. Note these will not be revenue losses to the central or other banks as they can issue digital money whenever required by literally typing in the amount!

It can be argued that loans can be issued at zero percent. For example, The Japanese bank lending rate for the month of September 2022 was 1.475 percent. This could be to cover the cost of the digital infrastructure required for the issue of digital currency. Today, after recovering the cost of the digital infrastructure and costs of banking, the lending rate could approach zero.

There must be a unidirectional conversion of cash to digital currency but not vice-versa. Wherever cash is created it should be treated as issuance of digital currency and must also be backed by physical supply. All deposits in digital currency will be 100 per cent guaranteed for the full deposit amount but the money can be spent or utilised digitally only but not for speculative purposes. Interest payable on a digital deposit could be higher than the interest payable on a cash deposit. This will further incentivize people to go digital. Digital transactions which result in profit can also be taxed at a lower rate than the profits created through any other means. Note a run on digital currency in Indian banks cannot occur.

Inflation

Care should be taken that all issuing of digital currency must be approved and sanctioned by the RBI (Central Bank). All current accounts or accounts directly associated with digital money should be directly connected to the central bank to receive the e-digital money. Loans will be issued directly by the RBI as well. This is to cater to any inflationary impacts at a branch level. The bank will have to send the cash to the RBI and issue the digital currency to its current account or other account holders. Banks can recover the cash from borrowers or find some other sources of cash to digitize the economy. Further, this also controls velocity and multiplier effects and thus that will have a consequential advantage around inflation too. Technically, for digital currency to penetrate the economy, all onshore banks are directly representing the central bank. Multiplier and Velocity effects, before digital banking, were required because the majority of the banking transactions were cash and cheque dealings and there was not enough physical cash to distribute (money supply lag). In the present digital age, physical currency is not required. This could be a case of zero taxation because all business will be transacted transparently in the digital banking infrastructure ledger spreadsheets.

Greater the exchange of money between hands i.e. velocity of money, the higher the inflation. An increase in the velocity of cash money has the propensity to cause inflation. Every time cash currency is transacted, there must be an equal value of physical supply created to nullify inflation. This is one of the aspects of digital currency.

In order to diffuse digital currency in the economy, banks have to take out the cash from the economy and replace it with digital rupees. Given there exists a 5.5 money multiplier effect currently because of cash transactions, if we have to issue one unit of the digital currency then we would not need to take out the 5.5 units of cash because every unit of digital currency produces only one unit of physical supply and gets exhausted. If velocity and multiplier effect were to be allowed then that amount of physical goods will be pro rata increase (one each per transaction). For example, with the current multiplier effect, 5.5 units of supply will have to be made for every unit of digital issue. This would nullify any inflationary or deflationary effects. 

In a single good economy with a price of $1, let us assume that $1000 is issued in digital currency as an interest-free loan to a producer to produce 1000 units of a good (since the price equals $1). Now, this $1000 will trickle down to the factors of production (land, labour, capital, and entrepreneur/ firm) as their respective incomes. This income will be used for the consumption of the same good and hence increase the quantity demanded by 1000 units. Once again the $1000 reaches the producer, which is used up to repay the loan or credit with Production Linked Incentives (PLIs). So, supply creates its own demand, and all goods produced are absorbed by its own factors of production also meaning, that each economic unit/ citizen is a consumer as well as a producer.

Saving and tax can create an inflationary and deflationary impact on the economy because of the leakage in the demand-supply pipelines. This would lead to a decrease/ Increase in digital currency from the market. If there is saving in supply pipelines then less goods would be produced leading to an inflationary impact. A decrease will create less physical supply and hence, an inflationary impact. On the other hand, if there is saving in the demand pipeline then this would create a deflationary impact. All savings should be kept in banks in digital mode and interest rates should be created digitally. And this money can be availed anytime digitally with a full guarantee on the deposit amount plus interest and to be spent on non-inflationary goods and services. Another method of controlling inflation would be to issue digital money to existing capacities that manufacture the goods that are contributing to inflation and the time lag in ramping up such capacity can be met via imports in digital currency in the short term.

Foreign Exchange in digital economy

Foreign Direct Investments (FDI) have to be discouraged by the Government as there is dual issue of the currency in the global economy. When for example 20 billion dollars Vedanta Resources raises for its joint ventures with Foxconn then in India it issues approximately 1240 billion rupees impacting global inflation. For hard currency requirements, Non-Resident Indians (NRIs) and People of Indian Origins (PIOs) could be taxed and 30 Million of them with a USD 4000 tax could yield 120 billion dollars per annum.   This foreign exchange can be immediately credited to payers of this tax in the manner of digital currency onshore accounts in India, no questions asked. And they will earn interest which will also be paid and credited to their Indian digital accounts. This $120 billion is enough for most of the critical imports in India. After all, its atma-nirbhar India and there is no digital money constraint.  We should also strike an agreement with the countries we import from, that those payments for such imports should be made in digital rupees only. And for the Make in India scheme, zero interest rate bearing lines of credit in INR should be awarded to foreign companies whose technology and products are considered critical to national economic security. 

It is recommended that the government need not go to its citizens for issuing interest-yielding bonds when it can digitally issue any amount of money that is backed by the supply of physical goods. Neither should the government issue any sovereign debt in a foreign currency and whenever it requires monies, it just can type the keys of the amount required.

Authors: PODS Book Research Team