Digital currency can effect positive change by formalising economic operations and increasing financial inclusion
he transition from physical cash to digital currency is a global trend observed in several developed and emerging economies, including Pakistan. This transformation has spurred discussions regarding the relative virtues of digital currency, particularly central bank digital currencies and conventional currency.
A CBDC is a payment instrument denominated in the national unit of account issued by the monetary authority. Retail CBDCs or general purpose CBDCs, are intended for broader economic use in facilitating everyday payment and transfer transactions, whereas wholesale CBDCs are designed for utilisation among financial intermediaries and can be likened to commercial bank reserves held at central banks.
Pakistan’s caretaker government has decided to launch a digital currency. This initiative aims to evaluate the potential cost savings associated with reducing the expenses related to printing and distributing physical currency. Central banks from The Bahamas, Nigeria, Jamaica, and the eight Eastern Caribbean Currency Union members have issued retail by December 2022.
China, Ghana, India, Kazakhstan, Korea, Russia, Sweden and Thailand have reached pilot phases. More than 90 countries are still conducting CBDC research. Some of the technical questions still need to be solved. Let’s examine whether the inclusion of digital currency into Pakistan’s financial system can significantly change the country’s monetary environment and economic stability, considering the economy has to operate under the IMF conditions.
Digital forms of money can significantly benefit Pakistan’s economy, provided the shift is carefully managed and appropriately regulated. However, low financial literacy, limited internet access and smartphone adoption can jeopardise CBDCs’ potential effectiveness as a monetary policy transmission mechanism.
Most Pakistanis require formal financial services. According to the World Bank’s 2021 Global Findex report, Pakistan’s adult financial inclusion rate is 21 percent – much lower than the global average of 69 percent. However, according to the recent Karandaaz Financial Inclusion Survey (K-FIS), financial inclusion among Pakistani women has increased recently.
Female financial inclusion hit a new high of 13 percent, up from previous surveys. Adoption of mobile phone money among adult women rose from 2 percent in 2020 to 6 percent in 2022. Women had 8 percent of bank accounts in 2022, up from 5 percent in 2020. In 2022, 47 percent of men were financially included, up from 36 percent in 2020. While significant strides have been made, it is essential to acknowledge that there is still room for improvement in achieving gender equality in financial inclusion.
Pakistan is known to have a large informal economy. A prominent example of evidence is the recent FIA raid at an under-construction house in Shamsabad Rawalpindi, where a substantial amount of foreign and local currencies, amounting to billions of rupees, was discovered. Digital currency has the potential to foster the formalisation of economic activities in Pakistan.
Individuals and businesses may find it more convenient to maintain accurate records of income and expenses, as DC transactions can be easily traced. However, the transition may be challenging for everyone in the informal economy, especially those with limited access to technology and digital skills.
New payment technologies have taken a long time to become widespread since human behaviours change slowly. With time, merchants may understand the benefits of accepting CBDCs because they don’t pay with credit card costs.
Cyber-security and digital fraud concerns may require establishing and enforcing a high cyber-security standard for DC service providers, such as CBDC issuers, wallets, exchanges and payment processors. These requirements should cover encryption, data security, safe key management and frequent security audits.
In essence, the potential implications of DC for Pakistan’s informal sector are dependent on several factors, including the regulatory strategy, the degree of investment in digital infrastructure and individuals’ and enterprises’ readiness to accept digital financial services.
The DC can effect positive change by formalising economic operations and increasing financial inclusion. It may also increase the efficiency and cost-effectiveness of cross-border remittances. However, to ensure a smooth transition and fully capitalise on the country’s economic benefits, the governments must carefully handle the problems connected with its implementation.
The State Bank of Pakistan should learn from the experience of countries where CBDCs are still underutilised. For instance, two years after inception, CBDCs make up less than 0.1 percent of the money in the Bahamas. One year after its launch, e-Naira adoption in Nigeria is 0.15 percent.
Since July 2022, Jamaica’s CBDC, JAM-DEX, has shown a modest but growing uptake. Cash made up 0.16 percent of the ECCU’s circulation at the end of March 2022. The People’s Bank of China has been running several pilot projects and reports that 0.13 percent of the total money (M0) was e-CNY by the end of December 2022.
Significant factors for a low uptake are lack of awareness, merchant infrastructure integration and customer comfort with mobile phone payments. Offline payment functionality has yet to become apparent due to technical issues. Moreover, new payment technologies have taken a long time to become widespread since human behaviours change slowly. With time, merchants may understand the benefits of accepting CBDCs because they don’t pay with credit card costs.
Successful implementation of DC could benefit from including financial literacy programmes, which can provide valuable guidance to individuals and businesses on the safe and effective utilisation of digital financial services.
DC transactions are typically recorded on either a block chain or a central ledger, which can offer high transparency and security by creating an unchangeable record of financial transactions. This transparency could discourage illegal activities and address corruption issues within the informal economy.
Cash is used as the predominant medium of exchange in most sectors in Pakistan. DC has the potential to decrease dependence on physical cash and encourage electronic transactions, thereby facilitating more efficient tracking and reporting processes. This could discourage instances of tax evasion and unregistered economic activity.
Adopting DC, including CBDCs, does not guarantee a complete eradication of physical currency. Several countries are currently considering hybrid systems that provide a combination of digital and physical currency options. The SBP should utilise various channels, including traditional and digital methods, to effectively manage economic variables such as inflation and interest rates.
This approach aims to cater to the populations’ diverse preferences and requirements. The outcome of the debate in Pakistan is expected to be influenced by various factors, including economic, technological and cultural aspects. Additionally, the policies and initiatives implemented by the SBP and government will play a crucial role in shaping the desired result.
The writer is a senior lecturer in finance and heads the Business Finance Programme at the Birmingham City University, UK. He tweets @HafizUsmanRana