Capital Markets Weekly: Further momentum in Central Bank Digital Currency development

October 22, 2021
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With over 80 countries now studying the potential development of
central bank digital currency (CBDC), momentum in CBDC development
was boosted over the last month by Turkey and Georgia moving to
start pilot phases in their respective CBDC development projects.
This accompanies the start of pilot schemes in Nigeria and Ghana,
with Nigeria particularly committed to early potential rollout, and
Ghana undertaking a far-reaching digitization program for its
public sector (discussed separately in our recent podcast and
Strategic Report).

Turkey’s CBDC pilot started against the
background of its president having declared “war” against
unregulated digital currencies. President Recep Tayyip Erdoğan
recently stated that “we have a separate war, a separate fight
against them” and “would never lend support” to such instruments.
Instead, he pledged “we will move forward with our own currency
that has its own identity”. Against this background, the Central
Bank of the Republic of Turkey (CBRT) had issued a press release on
15 September announcing the appointment of three technology
partners and its plans to run a limited CBDC pilot scheme. The
statement reported that CBRT had completed its “proof of concept”
initial phase, reviewing relevant technologies. It now intends to
develop a “Digital Turkish Lira Network” and run initial
limited-scale tests with the three firms appointed: based on this
phase, broader participation will be considered. CBRT will announce
the results of the pilot scheme in 2022.

Turkey is still at a relatively early stage of CBDC development.
Its current work is being conducted using “the principles of
experimental R&D activities”. It flags that “no final decision”
has been made whether to issue a central bank-sponsored digital
lira. The likelihood of extended development is further suggested
by CBRT’s statement referring to the potential extension of the
project, including “blockchain technology, use of distributed
ledgers in payment systems and integration with instant payment
systems”. A final decision on whether to proceed will be made only
after multiple technical options have been reviewed and a preferred
structure is chosen.

Georgia’s central bank plans to advance its “Digital GEL” project and run pilot testing of central bank digital
currency (CBDC) in summer 2022. National Bank of Georgia (NBG) Vice
President Papuna Lezhava was quoted by Coinbase website as stating
that “we want to be at the forefront” of the trend to develop CBDC,
highlighting an intention to trial it in retail sales next year.
Describing the new instrument as an “alternative to cash”, he
specified that the trial model would not require internet access
but would be based on blockchain technology. Lezhava argued that
the “main advantage” of CBDC would be its openness to new
technologies, with the central bank also targeting improved
financial efficiency and inclusion. As with Turkey, a cautious
approach appears likely. In May 2021, Lezhava had told Georgian
media that at least initially there would be restrictions imposed
on the use of digital GEL to minimize potential risks, including
limits on amounts for each transaction and restrictions on how much
could be held in digital wallets. He noted that much of the
operational detail would be decided after the pilot project is
concluded with that serving to test digital GEL’s resilience to
cyber-attacks.

Our Take

The growing global push for CBDC development is a logical
pushback by central banks against the development of initially
unregulated instruments such as Bitcoin as an alternative store of
wealth.

Multiple justifications are presented. These include lowering
payment costs, increasing financial inclusion, and facilitating
state payments to (and from) the public while avoiding potential
AML/CFT, investor misinformation, and outright fraud risks
associated with unregulated cryptocurrency.

Counterbalancing this, the need for CBDC is less obvious where
existing electronic payment systems are already well developed,
where there is a strong level of private-sector financial
innovation (such as Nigeria and Kenya’s prolific fintech sectors),
or where the national currency is generally unattractive due to
high inflation and persisting depreciation (an issue that currently
would affect Turkey). Two other concerns are whether a CBDC is
configured in a way that drains the established banking sector’s
deposit base – with the central bank then taking a larger role in
funding banks – and the resoluteness of any CBDC’s cybersecurity.
Any lapses in the latter would expose a country to significant
dislocation risk from outages in or theft from its CBDC system,
making cautious and rigorous development highly desirable.

While we expect more announcements of pilot schemes, the actual
rollout of state digital currency is limited so far, and likely to
be a gradual but potentially growing process. Two key indicators of
progress would be a decision by the US Federal Reserve to progress
with CBDC development and new moves by mainland China towards
implementing a nationwide CBDC rollout. The use of new technology
also will continue to extend in the private sector – already
exemplified by the rapid development of mobile-based banking in
South Africa – with major banks either working inhouse and/or with
technology partners to benefit from its benefits, such as easier
and cheaper cross-border fund transfer arrangements (a priority
objective for the Bank for International Settlements, whose digital
hub is now involved in several multinational CBDC development
projects).

This week, you may notice that our Capital Markets Weekly looks
a bit different. Based on feedback from the growing number of
readers, we plan to publish this fortnightly and focus on a limited
number of key capital market developments. We will publish ad-hoc
reports on key financial-sector developments (if any) in the
alternate weeks. If you have other suggestions – or prefer the
prior arrangement – please let
us know
.


Posted 22 October 2021 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, IHS Markit

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