Unpacking India's CBDC Pilots as Country Prepares for Digital Rupee

India wants to launch its central bank digital currency at a national level by the end of 2023, but early into its pilot, the Reserve Bank of India has identified challenges, several people familiar with the matter said.

India launched two CBDC pilots last year. The first, a wholesale CBDC effort (CBDC-W), began on Nov. 1 with the participation of nine banks. The other, a retail CBDC (CBDC-R) pilot, launched on Dec. 1 in four cities – Mumbai, New Delhi, Bengaluru and Bhubaneswar. Initially, four banks, including the State Bank of India, ICICI Bank, Yes Bank and IDFC First Bank participated.

It has "now been extended to 15 cities with Chandigarh as the newest addition," a senior official told CoinDesk. "More than 50,000 customers and 10,000 small and big merchants have been onboarded now," including Reliance Retail, the nation's largest retail chain.

The CBDC-R is meant for the private sector and Indian citizens. The wholesale CBDCs are restricted to financial institutions and are meant to improve the efficiency of interbank payments. While the government told parliament India will issue a CBDC-R within the financial year 2022-23, it’s not completely clear when it will be implemented.

India’s charge towards CBDCs isn’t exactly unique. Internationally, 105 countries, representing over 95% of global GDP, are exploring a CBDC, according to the Atlantic Council’s Central Bank Digital Currency Tracker.

Some nations have collaborated to explore different use cases of CBDCs under the guidance of the Bank for international Settlements (BIS).

The central banks of Israel, Norway and Sweden have teamed up to explore how CBDCs can be used for international retail and remittance payments. China, Thailand, Hong Kong and the United Arab Emirates are attempting something similar in Project mBridge. Australia, Malaysia, Singapore and South Africa came together in Project Dunbar.

India has not entered into any CBDC project with any country so far but has indicated it will occur in the future. "Collaboration with stakeholders including with BIS on developing common global standards for facilitating easy cross-border transactions, will be a way forward," a central bank document said.

India’s current key motivations appear to be divided between what has been publicly stated and its private geopolitical preparations.

Publicly, the RBI has said the CBDC will provide an additional option to the currently available forms of money that is easier, faster and cheaper to use than existing payment rails, along with the transactional benefits of other forms of digital money.

Privately, as an emerging economy, one of the world’s largest populations in 2023, and the fifth largest in terms of GDP, India’s geopolitical motivation is to counter the dollarization of the global economy.“

In the context of the internationalization of the Indian rupee, an Indian CBDC will make it easier for the nation to get international acceptance because it is digital,” said an official working on the CBDC efforts. “For emerging markets, it is a good weapon to have so that in future when we are looking for internationalization this can be one good help.”

The primary challenge for India’s CBDC project is marketing it to the nation’s populace. Indians are grappling with several questions around CBDCs, including distinguishing between wholesale and retail CBDCs, the digital rupee and eRupees, and whether a blockchain is even involved.

This ambiguity extends to a lack of understanding around India’s public policy goal for a CBDC. Even Nandan Nilekani, the prime architect of India’s biometrics-based unique identity program and the co-founder of tech firm Infosys, has sought clarity about it.

The broad objective of India’s CBDC has been to “modernize the current physical (cash) currency system,” according to a senior official working on the CBDC efforts. But what that actually means has not been detailed for the general public. India’s government has begun launching “awareness” campaigns warning citizens about the risks of investing in cryptocurrencies at large, contrasting those with the still-developing CBDC projects.

India’s government has turned to the country’s media platforms to explain what the CBDCs are, and what they may be used for.

In the past few weeks, India’s news networks, particularly government-run and business channels, have focused on explaining CBDCs and their potential role within India’s economy.

This is a shift from earlier this year when news organizations were more focused on advertising crypto exchanges and content focused on trading.

The shift may be because the Advertising Council of India released guidelines for crypto-related advertisements, requiring disclaimers calling crypto products “highly risky” and unregulated.India’s central bank is now “pushing for education around CBDCs,” an official working on the CBDC efforts told CoinDesk.

“Nobody expected RBI to launch the pilot so quickly,” said the official. “So, they [media and financial experts] are talking about it now because they are surprised.”

India already has a ubiquitous cashless movement: the Unified Payments Interface (UPI). UPI allows citizens to pay for groceries and other goods using a QR code linked to their bank account, which automatically transfers money from their bank accounts to a merchant's account.

Reserve Bank of India (RBI) Governor Shaktikanta Das said a CBDC will remove the need for a bank intermediary, adding that “it’s important to clarify this point because a lot of people are asking what is different between UPI and CBDC.”

“UPI is bank money. This is central bank’s money,” said a person familiar with the RBI’s work on awareness around CBDCs. ”This will have all the features of physical currency without the risks. It's different from UPI because this is a currency system, not a payments system.”

Cash presents risks of tangible money to steal, more money laundering and counterfeiting.

RBI Deputy Governor T. Rabi Sankar said a CBDC could maintain cash-like anonymity, which is not available in UPI.

“What exactly will happen will depend on how things evolve,” Sankar said. “But anonymity is a basic feature of currency and we’ll have to do that. And to that extent, it is again different from UPI,” which is not anonymous because it carries a digital footprint.

The CBDC also doesn’t require any time for settlement between the banks of the buyer and seller, unlike UPI.

One of the central bank’s “key motivations for exploring the issuance of CBDC” is to “foster financial inclusion,” a central bank document said.

At the moment, using a CBDC requires a bank account. If the bank and city are currently involved in the pilot, your bank, in coordination with the RBI, can create a digital wallet for you and transfer cash to it. Then one can start using the CBDC to transact. The RBI will maintain a ledger of the transactions. The entire process will remove the settlement mechanism between banks, adding efficiency to the payment system, said an official working on the CBDC efforts.

Although this aspect still needs to be tested, a citizen won’t necessarily need a bank account to use the CBDC, the official said. Citizens who don’t have bank accounts cannot use UPI.

“The entity authorized by the RBI to open digital wallets for people in rural areas will do the necessary KYC (Know your customer) checks. One need not have a bank account to have a digital wallet. This will happen in the future depending on each pilot,” said the official.

While the CBDC could bank the unbanked, the problem is Indians prefer to keep their savings at home.

A 2017 World Bank report revealed that more than 80% of Indian adults have bank accounts, but a survey conducted by an entity under India’s Finance Ministry found that most respondents (52%) prefer to keep their savings at home.

The money you take out from your bank account to put in your CBDC wallet will not accrue interest like money in your bank account does, according to a person aware of the current thinking of the RBI.

One of the major advantages of the CBDC is that it will “drastically” reduce operational costs by reducing the annual recurring expense of physical currency.

At the moment, UPI is free to drive the government’s objective of a digital India and a cashless society. But the operational cost of UPI may exceed 8400 crores INR ($1 billion) annually, based on an estimate from WHO. The Payments Council of India estimates the annual loss to be around $664 million. The government has stated that this loss would be absorbed by savings from the nation using less cash.

India spends approximately $600 million to print cash alone and even more to manage it. And 14% of India’s $3.18 trillion GDP is cash in circulation. India is exploring whether it can lower this component.

It’s still to be seen whether the reduction in cost will be worth the advantages on offer.

The central bank will bear the cost of the CBDC infrastructure, said a person familiar with the matter. The financial considerations would involve the central bank taking responsibility for the digital vault of millions of Indians.

The CBDC has the potential to replace UPI, but the RBI does not “envisage a picture without UPI,” according to a senior official working on the CBDC efforts.

“As of now, it looks like they will complement each other. The CBDC will target the physical cash component. If the comfort increases and people refuse UPI, then so be it. Let the competition be there,” the senior official said.

It’s unclear whether the nation will provide any incentive for citizens to adopt CBDCs amid the UPI success and whether it will even come to that.

In parliament, Finance Minister Pankaj Chaudhary said the CBDC, currently in the trial phase, has components based on blockchain technology.

“It’s part DLT [distributed ledger technology] and part API [Application Programming Interface],” said the senior official. “We are testing various technologies. Maybe we will see other technologies that can cater to India’s population. It’s not a challenge, but we are trying to find the best possible technology.”

The API is not linked to any blockchain, which means India’s CBDC and its association with blockchain remain opaque.

“It’s a closed user group and we are trying with limited numbers to check the tech and every aspect, right from creation to usage, and this is working well. Gradually, it will be expanded to other cities and more users,” said the same senior official.

One of the crypto industry's idealized use cases is as a currency, letting people buy and sell goods or services as they would with cash. But that had risks that came to the fore with the crypto contagion involving Terra, hedge fund Three Arrows Capital and the FTX exchange.

Now, the central bank espouses CBDCs as a mechanism that provides the public with uses that any private virtual currency can provide, but without the associated risks of the broader crypto industry.

The exact uses for the CBDCs are still to be determined.

One of the officials working on the CBDC efforts told CoinDesk that the retail CBDC could be programmed for specific uses. For example, any tokens distributed as part of a government subsidy project could only be spent on goods for that project.

“We are looking at various other use cases like offline payments and programmability. And based on the outcome of our experimentations, we will have the best CBDC with the best features,” said the official.

The central bank and the government want India’s soon-to-be world’s largest population to adopt CBDCs for reasons beyond the possible technological advantages.

A CBDC has often been thought of as a geopolitical weapon that could give one nation an advantage over the other or even change the global financial order. China’s early exploration of the CBDC is a looming threat. An Oxford University law faculty paper has discussed this at length. Deutsche Bank has stated CBDCs could challenge the U.S. dollar's dominance. Former U.S. government officials and academics even conducted a “war game" exercise examining the possible role a CBDC issued by China could play in geopolitical strife.

Nineteen of the G-20 countries, the 19 nations with the largest economies plus the European Union bloc, are exploring a CBDC, with 16 already in the development or pilot stage.

India took charge of the G-20 presidency on Dec. 1, 2022, and a series of meetings have already taken place with the Indian central bank's entourage extending to over 20 people, according to a government official involved in the proceedings. India is looking to coordinate global crypto rule-making, which involves several contours of the CBDC framework.

It’s also not clear how or by how much CBDCs will help in the cross-border payments space.

India began pushing for CBDC coordination during its G-20 presidency regarding international remittances, said people familiar with the matter.

CBDCs could eliminate the high costs, slow speed, limited access and insufficient transparency in international remittances for Indians, says the RBI.

India is the world’s largest recipient of remittances, receiving $100 billion in 2022, according to a World Bank report.

The RBI concept note called for central banks to incorporate cross-border considerations in their CBDC design from the start and coordinate internationally” to help “overcome key challenges relating to time zone, exchange rate differences, as well as legal and regulatory requirements across jurisdictions.”

India has stated in the note that “​​security has to be the prime design concern while designing CBDCs,” but simultaneously declared a timeline stating it will issue a CBDC within the financial year 2022-23.

Read More: India's Central Bank Crystalizes CBDC Vision in Concept Note