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A recent advertisement by a group of Indian crypto exchanges claimed that Indian citizens have over ₹6 trillion invested in crypto assets. A separate crypto platform company said that more than 100 million Indians have invested in crypto assets. These numbers are most likely an overestimate, even if we consider the sharp increase in the prices of various crypto assets in recent months.

However, the growing number of Indians parking money in these new-age assets does seem to have rattled policymakers. Reserve Bank of India (RBI) Governor Shaktikanta Das said last month that crypto assets are a threat to India’s financial system. The government now plans to table a bill regulating crypto assets in the country. The details are not clear. One possibility is that crypto assets such as Bitcoin will be allowed to continue as an investment alternative, but will be banned as a currency used for economic transactions. The government will also clear the road for RBI to introduce its own digital currency. A senior RBI official has said that the pilot launch of a new central bank currency could happen as early as the first quarter of next financial year.

An Indian central bank digital currency (CBDC) is inevitable. A survey of central banks earlier this year by the Bank of International Settlements showed that 14% of the surveyed institutions had launched pilot projects, while 60% were experimenting with the technology. A lot has already been written on the supply side of the CBDC opportunity—from whether it would initially be open for retail or wholesale payments, for domestic or international payments, and how it can be made interoperable with the existing payments system, to data protection concerns, for example.

However, it is also important to focus attention on the demand side of the CBDC opportunity. How will ordinary citizens respond to a CBDC, which in effect will give them an opportunity to bank directly with RBI? Households generally hold most of their liquid financial assets in bank deposits rather than in cash, or bank money rather than central bank money. A CBDC will provide them an option other than cash to hold central bank money in order to make payments or protect the value of their savings.

There are three sets of issues worth highlighting when it comes to understanding the potential demand for CBDCs from the private sector.

First, much depends on how households think about their balance sheets. In India, for example, household balance sheets have ₹17.3 trillion of bank deposits, compared to ₹2.4 trillion of cash. There will be a minimal impact in case cash is converted into CBDC holdings, since one type of central bank money is being converted to another. However, a sudden movement of financial savings from bank deposits to a CBDC could create financial instability, especially during times of economic stress. In 2016, the initial weeks after demonetization saw people forcibly convert their cash into bank deposits, or central bank money into bank money. Now think about this as a permanent feature of the financial system.

Second, the way households dynamically move from one form of money to another will depend on the design of our CBDC. One of the major factors affecting such behaviour will be the interest rate offered on CBDC holdings. Zero interest rates on these holdings will in effect mean that they are no different from cash, which is also a zero-interest liability of the central bank. People will then hold the CBDC only for payments. However, the situation will get more complicated if interest rates are involved and the CBDC becomes a store of value. Also, the ease of using the CBDC, for example through existing digital wallets or the United Payments Interface, will be an important determinant of household behaviour, especially switching between the CBDC, cash and bank deposits.

Third, quantitative estimates by several economists show that demand for a CBDC will be sensitive to macroeconomic factors such as household income, income distribution, the share of household funding of the banking system etc. Most of the estimates available right now are for rich economies, so more work needs to be done on this in the Indian context. For example, Bank of Canada economist J. Li has used household survey data to estimate that expected demand for a CBDC by Canadian households could range from 4% to 55% of their combined holdings of cash and bank deposits, depending on the design of Canada’s sovereign digital currency.

Economist James Tobin had way back in 1985 proposed that households should be allowed to have direct accounts with the US central bank. The development of new digital technologies now makes that possible. A lot of the ongoing debate on an Indian CBDC is focused on what RBI should do; far less attention is paid to the equally important question of how households will respond.

A final technical point: The demand for money is as important as the supply of money in monetary economics. It should be the same for CBDCs. Unstable demand for money has foxed central bankers ever since the financial liberalization of the mid-1980s expanded portfolio choices of the private sector, both households and businesses. It will be the same with CBDCs. Monetary management will become more complicated.

This article was originally publish in The Mint on 1 December 2021.

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The opinions expressed in this essay are those of the authors. They do not purport to reflect the opinions or views of CCS.