The coming year will be rather interesting because it could see several budget proposals come to fruition. The most obvious that comes to mind is the LIC divestment that was supposed to close in March but now looks likely to be completed in the next fiscal year. But the question is when will it be done?
The course of the war is not known and while this uncertainty has dampened the IPO now, there is no guarantee that the situation will be better in April or May. In fact, as 2021-22 draws to a close, markets appear to be back to normal. In retrospect, perhaps the government could have launched the IPO.
The other two major budget announcements relate to the issuance of sovereign green bonds and a central bank digital currency. Both of these launches will be a joint effort between the government and the RBI. While geopolitical turmoil could make the current time inopportune for experimentation, the government seems firm on both proposals and they will most likely be rolled out.
The sovereign green bond is an innovative idea. It will be part of the government’s borrowing program. The government’s gross borrowing program is pegged at Rs 14.95 lakh crore. This money is collected by the government to fund the deficit which involves overspending on both the capital and revenue accounts. But since the money is fungible, it’s hard to know where the borrowed money is going. In the case of sovereign green bonds, however, an exception must be made. The SGB (sovereign green bond) raised will be part of the overall borrowing program and must be used for projects that comply with ESG (environment, social and governance) standards. Therefore, if the bond is used to finance an energy or road project, or if it is used to finance revenue expenditures, it must comply with ESG standards. The basics for this must be made in advance.
Pricing these bonds will be tricky. As these bonds are different from G-secs (government securities), they may need to offer a higher yield, as all ESG-compliant companies have to make special investments that will increase costs. Or will these bonds be priced at lower rates to facilitate the implementation of ESG? Moreover, given the low interest rates prevailing today – real deposit returns are negative – SGBs can be issued as tax-exempt bonds, open to the public. This will generate a lot of interest as these are government issued bonds. The RBI and the government have been trying to bring retail investors into the government’s borrowing scheme, and this move will speed up the process.
Central bank digital currency, also known as CBDC, is also an interesting concept. This seems to be the result of the proliferation of cryptocurrencies. This has prompted several central banks to develop their version of digital currencies. This reasoning could be misleading because cryptos are an investment option, unlike a CBDC which substitutes for currency. To launch such a currency, the RBI needs to answer some basic questions.
First, will a CBDC replace currency at some point in the future? Is it just another option for the public or will physical currency disappear? It should be remembered that there are several sections in India that are unfamiliar with technology.
Second, if it is to co-exist with currency, how different will it be for the public from the digital payments that are made today? This is a relevant question as there seems to be a large volume of money in the system after demonetization. Will people have to choose between a mobile wallet and a CBDC wallet?
Third, any issuance of CBDCs on a voluntary basis also raises a question about the security of owner information. Aadhaar is supposed to ensure that an individual’s information is confidential, but there is skepticism. This is why the CBDC must be clear on the issue of confidentiality, as it is bound to be a matter of concern. If not confidential, even a CBDC, given as a gift to a couple at their wedding, will be tracked by the tax department.
Fourth, what will be the future of the banking system as the CBDC spreads? If people are to be incentivized to voluntarily move to the CBDC, the money exchanged must earn interest, otherwise all the money will go to bank accounts where a minimum rate of interest can be earned. Will we need savings bank accounts with commercial banks in case all money goes to RBI? Will we then need ATMs for cash withdrawals? Will bank tellers become redundant? Will we need logistics companies that handle cash? These trickier issues need to be addressed by the RBI, as the widespread use of the CBDC will gradually lead to a diminishing need for banks.
Fifth, there is the issue of security, as any financial system that runs on technology can be hacked. It must be infallible and resistant to power outages. Such systems should be created and tested before a CBDC is introduced. There is a real danger of increased cyber fraud as the majority of the population is not tech savvy. Likewise, there are always downtimes for banking servers when banking transactions cannot be completed. This cannot be the case with CBDC as it needs to be available 24/7.
If successful at the central level, green bonds can be replicated by states. The case for CBDC is compelling to follow other countries’ central banks and opportunities to take advantage of new technologies like blockchain. But before embarking on these measures, it may be useful to keep in mind the problems pointed out above.
This column first appeared in the March 24, 2022 print edition under the title “Changing the Face of Money.” The author is Chief Economist, Bank of Baroda and author of Hits & Misses: The Indian Banking Story. Views are personal