Financial Inclusion and Central Bank Digital Currency in India Building Blocks and Future Road Ahead

Introduction

Financial inclusion is a critical aspect of India’s economic development strategy, aiming to provide access to financial services to all segments of society, particularly those who have been traditionally excluded from the formal banking system. The Reserve Bank of India (RBI) defines financial inclusion as the process of ensuring access to a range of financial services, including banking, credit, insurance, and payments at an affordable cost to all individuals and businesses, irrespective of their socio-economic status or geographical location.

CBDCs can enhance accessibility to financial services by offering a digital currency that does not require a traditional bank account. This is particularly beneficial for vulnerable sections of society, such as low-income individuals and those residing in remote areas with limited banking infrastructure. Moreover, CBDC can facilitate low-cost transactions, ensuring that even small value transactions remain affordable. Also, CBDC have the potential to create a level playing field by providing access to the same financial infrastructure for all individuals, regardless of their background or location. This can help reduce disparities and promote inclusive economic growth. By leveraging blockchain technology, CBDC transactions can be recorded on a transparent ledger, reducing the risk of discrimination, and promoting fair treatment for all users.

RBI stated that CBDC is a digital token that represents legal tender and is being issued in equivalent denominations to paper currency and coins. Participating banks will offer a digital wallet to transact with digital currency (e-R) for the users. Transactions can take place between both person to person (P2P) and person to merchant (P2M). Also, CBDC will not bear any interest similar to cash and can be converted into alternative forms of currency such as bank deposits.

According to Finance Minister, Ms. Nirmala Sitharaman, digital currency will lead to a more efficient and cost-effective currency management system. Also, adopting CBDC as a national currency can help India add $1 trillion to its economy by 2032, as per a recent estimate. As of March 2023, the circulation of CBDC or e-rupee amounted to Rs. 16.39 crore, according to RBI’s Handbook of Statistics on the Indian Economy for the fiscal year 2022-23. Among the overall e-rupee circulation, Rs. 10.69 crore constituted Wholesale CBDC, while Rs. 5.70 crore represented retail CBDC. Daily transactions for retail CBDC are currently hovering around 18,000, significantly below the RBI’s ambitious goal of achieving one million transactions per day by the end of 2023.

Literature Review

The development of Central Bank Digital Currency (CBDC) is at a nascent stage. According to (BIS, 2018), CBDC is a fiat currency issued by central banks in digital form with a store of value and unit of account. (Ozili, 2022) defines CBDC as a currency in digital form issued by central banks that appears on the liability side of the balance sheet of the issuing banks. The most widely accepted definition of CBDC is that it is a digital legal tender (IMF), coming under the direct liability of the monetary authority.

Designs and Approaches of CBDC

CBDC represents a digital legal tender with the core functions of money: medium of exchange, unit of account, store of value, and standard of deferred payments. CBDC designs fall into distinct classifications:

• Ledger Architecture: Token-based (anonymity, bearer asset like physical cash) vs. Account-based (requires centralized digital identity verification).
• Wholesale vs. Retail: Wholesale CBDC is restricted to financial institutions for interbank settlements (e.g., Project Jasper in Canada, Ubin in Singapore, and Inthanon in Thailand). Retail CBDC (‘general purpose’) is distributed directly to households and businesses.
• Interest-Bearing vs. Non-Interest-Bearing: Interest-bearing CBDCs mimic bank deposits and can directly transmit monetary policy, whereas non-interest-bearing CBDCs function as digital cash.
• One-Tier vs. Two-Tier Distribution: In a one-tier model, the central bank directly manages accounts. Under a two-tier model (adopted in India and China’s DCEP), the central bank issues CBDC backed by reserves, but commercial banks and financial intermediaries distribute digital wallets to the public.

Research Objectives and Methodology

• Objective 1: To explore the factors affecting CBDC designs and approaches.
• Objective 2: To identify the opportunities and challenges in a CBDC rollout for financial inclusion in India.

The study utilizes a systematic literature review methodology, retrieving scholarly contributions from the SCOPUS database using keywords such as ‘CBDC’, ‘Digital currency’, ‘Design of CBDC’, ‘CBDC implementation’, and ‘CBDC and Financial Inclusion’.

Factors Affecting CBDC Design Choices

1. Acceptance by Merchants and Intermediaries: Digital payment volumes reached approximately 5,763 trillion by November 2023. Merchant acceptance is critical, requiring seamless point-of-sale processing and supportive RBI incentives.
2. Value Propositions: Offering zero-cost or fee-free transactions, simplicity, and safety to incentivize adoption among financially underserved groups.
3. Facility for Offline Use: Developing tokenized offline hardware/software wallets enabling peer-to-peer settlement in areas without internet connectivity.
4. Capability of Use in Remote Areas: Designing lightweight, affordable, user-friendly solutions that complement existing initiatives like the Pradhan Mantri Jan Dhan Yojana (PMJDY).

According to the RBI (Committee on Financial Inclusion, Chairman: Dr. C. Rangarajan, 2008), financial inclusion is defined as “the process of ensuring access to financial services, timely and adequate credit for vulnerable groups such as weaker sections and low-income groups at an affordable cost”. Approximately 190 million adults in India lack formal bank accounts, placing India second globally after China.

Opportunities and Challenges in a CBDC Rollout

1. Opportunities for Financial Inclusion

• Alternative for High-Volume, High-Value Transactions: RBI’s Financial Inclusion Index rose from 49.9 (2019) to 53.9 (2021). Total RTGS volume increased by 37%, UPI scaled past 456 crore transactions per month, supported by a ₹1,300 crore government incentive scheme.
• Countering AML and Financial Terrorism: Transparent distributed ledgers provide regulatory authorities with real-time auditability to trace suspicious fund flows and curb illicit financing.
• Improved Security and Operational Resilience: Mitigates cyber fraud through robust cryptography; CERT-In recorded over 39,000 cybersecurity incidents in 2022, highlighting the necessity of sovereign-backed cyber-resilient infrastructure.

Figure 2: Growth Rate in Selected Payment Systems (Y-o-Y Growth)

2. Systemic Challenges

• Overdependence on Cash: Cash remains the predominant medium for small transactions among low-income households.
• Connectivity & Device Chasm: Approximately 550 million individuals use feature phones lacking internet, and 845 million smartphone owners do not regularly utilize mobile banking.
• Circulation & Operational Costs: Substantial technological outlay required to sustain secure, zero-failure sovereign ledgers.

Figure 3: Preferred Payment Mode Distribution (RBI Survey 2022)

Way Forward & Conclusion

To accelerate adoption, the RBI is enabling full interoperability between e-Rupee wallets and UPI QR-code networks, and exploring CBDC integration into the wholesale call money market. Targeted merchant incentives, fee-free structures, and offline usability will be pivotal to overcoming cash inertia.

A thoughtfully designed Retail CBDC emulates cash without credit risk, serving as an accessible on-ramp to formal finance for excluded populations. Addressing infrastructural, literacy, and technological hurdles will ensure CBDC drives sustainable, inclusive growth across India.