#122 Naya Paisa, Purana Qissa 🎧

While excellent newsletters on specific themes within public policy already exist, this thought letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways.

Audio narration by Ad-Auris.

---

Global Policy Watch: A Mint With a Role

- RSJ

The People’s Bank of China (PBOC) has been trialling a form of digital Yuan for the past year. Last week the trials entered their second phase. (Umm, they seem to have more phases for this than for developing their Covid vaccines).

The Wall Street Journal woke up to the digital Yuan (paywalled) last week with this article that starts off like a Marquez novel:

“A thousand years ago, when money meant coins, China invented paper currency. Now the Chinese government is minting cash digitally, in a re-imagination of money that could shake a pillar of American power.”

What’s not to like an article that begins with hyperbole?

But there’s some grain of truth there. Before we go further we need to make sense of sovereign digital currencies or what’s now being called Central Bank Digital Currencies (CBDC).

What’s Money?

Like we have written in an earlier post, money performs three roles for us: it is a store of value, it is a medium of exchange, and it is a unit of measure. Through it we save for the future, pay for goods and services and measure the value of very different things using a common unit. These roles mean anything that aspires to be a currency (the usable form of money) should have a relatively stable value over time and should be widely acknowledged as a store of value and unit of account among people. If it does so, the network effect takes over after a while and it becomes a widely used currency.

Throughout history, a key feature of a sovereign state was its control over the supply and circulation of money that’s used within its boundaries. The royal mints, after all, have been around for more than two thousand years. As modern nation-states emerged through the 19th and 20th centuries and as global trade increased, central banks emerged to manage the monetary system and provide financial stability.

There are three forms of money in any modern economy:

• Banknotes: These are physical paper currency notes issued by the central bank that we all use in our everyday lives. This is a direct promise by the central bank to pay the holder of the note a specified sum of money. This promise is printed on all currency notes.

• Bank Deposits: Ordinary people and businesses don’t hoard banknotes to conduct their business. They deposit their money in commercial banks. These deposits are stored in electronic form by these banks. The banks offer two services to their customers. They convert these deposits to central bank money in the form of banknotes when you demand it at an ATM and they offer to transfer your money to someone else through a payment system that exists between banks. Unlike banknotes, your deposits aren’t risk-free. They aren’t backed by any sovereign guarantee. A bank will be able to convert your money into banknotes only if it is solvent and it is able to honour its commitments. We have seen instances of a bank failing to do so in India (Yes Bank, PMC etc).

• Central Bank Reserves (“reserves”): Commercial banks have their own accounts with the central bank where they deposit their funds. These deposits are used by banks to pay each other to settle transactions between them. The reserves are the other form of central bank money apart from banknotes. These are risk-free and therefore used for settlements among commercial banks.

Where does CBDC then fit in?

Simply put, a CBDC is a digital form of a banknote issued by the central bank. Now you might think we already use a lot of digital money these days. Yes, there’s money we move electronically or digitally between banks, wallets or while using credit/debit cards in today’s world. But that’s only the digital transfer of money within the financial system. There’s no real money moving. The underlying asset is still the central bank money in the form of reserves that’s available in the accounts that commercial banks have with the central bank. This is what gets settled between the commercial banks after the transaction.

This is an important distinction. We don’t move central bank money electronically. But CBDC would actually allow ordinary citizens to directly deal with central bank money. It will be an alternative to banknotes. And it will be digital.

CBDC: The Time Is Now

So, why are central banks interested in CBDC now?

There are multiple reasons.

One, cryptocurrency that’s backed by some kind of a stable asset (also called ‘stablecoin’) can be a real threat as an alternative to a sovereign currency. Stablecoins are private money instruments that can be used for transactions like payments with greater efficiency and with better functionality. For instance, the current payment and settlement system for credit cards in most parts of the world has the merchant getting money in their bank accounts 2-3 days after the transaction is done at their shops. A digital currency can do it instantly. For a central bank, there could be no greater threat to its ability to manage the monetary system than a private currency that’s in circulation outside its control.

Two, in most countries, there’s an overwhelming dependency on the electronic payment systems for all kinds of transactions. As more business shifts online and electronic payment becomes the default option, this is a serious vulnerability that’s open to hackers and the enemy states to exploit. A CBDC offers an alternative system that’s outside the payment and settlement network among commercial banks. It will improve the resilience of the payment system.

Three, central banks need to offer a currency solution for the digital economy that matches any form of digital currency that could be offered by private players. Despite the digitisation of finance and the prevalence of digital wallets in the world today, there’s still significant ‘friction’ in financial transactions all around us. You pay your electricity bill electronically by receiving the bill, then opening an app and paying for it. Not directly from your electric meter in a programmed manner. That’s just an example of friction. There are many other innovations waiting to be unleashed with a digital currency. Central banks need to provide a platform for such innovations within an ecosystem that they control. CBDC offers that option.

Lastly, digital money will reduce transmission loss both ways. Taxes can be deducted ‘at source’ because there will be traceability of all transactions done using CBDC. It will also allow central banks and the governments to bypass the commercial banks and deliver central bank money in a targeted fashion to citizens and households without any friction. The transmission of interest rates to citizens for which central banks depend on commercial banks could now be done directly.

While these are the benefits of a digital currency, there are other massive macroeconomic consequences including the loss of relevance of bank deposits that we have with our banks. A CBDC that offers interest would mean we will have a direct deposit account with the central bank. This will mean a move away from deposits in banks to CBDC with the central bank. Also, the nature of a bank ‘run’ will change. Today a bank ‘run’ means a rapid withdrawal of banknotes from a bank by its depositors who are unsure of the solvency of the bank. This takes time and is limited by the amount of money available in ATMs. In a CBDC world, the ‘runs’ will be really quick and only constrained by the amount of CBDC issued by the central banks. Depositors will replace their deposits with CBDC pronto.

This secular move away from deposits will increase the cost of funds of commercial banks. They will have to depend on other sources of funds than the low-cost deposits that customers deposit every month in the form of salaries to them. A reduction in deposits will reduce the availability of credit in the system. This will have a repercussion on the wider economy. It will also mean greater demand for reserves from the central bank by the commercial banks to provide credit to their customers. Central banks will increase their reserves and their balance sheets will become bigger. In summary, central banks will become more powerful.

China’s Digital Yuan Play

For these reasons, I believe CBDC is inevitable in this decade. Central banks will have to contend with the competition of cryptocurrency and the needs of the digital economy. They will find a mechanism to create a ‘platform-based model’ where the central banks create CBDC using a Distributed Ledger Technology (DLT) or a centralised ledger model while allowing private players to provide interfaces for customers to deal with this ledger. They will have to provide some level of comfort on privacy to their citizens by separating the transaction layer of CBDC from the core ledger.

But for China, the benefits of a digital Yuan do not just stop there. Beyond these benefits, a CBDC is a boon for a surveillance state as it turns into an ‘eye in the sky’ for every transaction happening in the economy. For China where all banking is owned by the state, the secular shift from deposits of commercial banks to CBDC is also a lesser problem. And most importantly, China is looking at leadership in CBDC to replace the US Dollar in global trade. A digital Yuan is the most feasible option for it to challenge the entrenched ‘dollarisation’ of the physical currencies around the world. 88 per cent of global trade is done using the US Dollar and it is what sustains the Dollar as the global reserve currency. For China to replace the US as the future global superpower, it will have to find ways to make Yuan the reserve currency. An early lead in adopting CBDC for domestic and cross-border payments is a great option to make a real fist of it.

China’s early trials in this space will force a response from other large economies on CDBC. The interoperability of sovereign CBDCs and how quickly the US is able to put together a CBDC alliance that counters China will be interesting to watch. In the meantime, I expect the current Chines regime to overplay its hand here like it has been usual for it in the last few years. Expect China to play hardball with the digital Yuan in global trade. This will be an interesting space in geo-economics to watch.

---

---

PolicyWTF: Casually Banning Films Committee

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

Most film certification authorities in democratic republics categorise movie content according to age-appropriateness and nothing more. But India’s is an exception. The Central Board of Film Certification (CBFC) — commonly referred to as the “Censor Board” — also plays the role of a film editor. The CBFC is empowered to ask filmmakers to drop certain scenes. Not just that, the CBFC in its wisdom can just plainly refuse to certify a movie. In such cases, filmmakers have the option of appealing to the reviewing committee of the CBFC. If even that fails, they could hitherto appeal to a 5-member Delhi-based tribunal called the Film Certification Appellate Tribunal (FCAT). This tribunal has now been shut down through an ordinance along with eight other tribunals. The stated intent is that this move will streamline legal recourses. Filmmakers will now have to appeal to High Courts directly and wait for the law to take its own (long) course. In other words, “tareekh pe tareekh, tareekh pe tareekh, tareekh pe tareekh…”

You would have already guessed why this is a PolicyWTF. Higher transaction costs, the existing burden on our High Courts, lack of state capacity, yadda yadda yadda. You can read these arguments here, here, and here. I won’t go there.

Instead, let’s address the larger PolicyWTF - the CBFC itself. As long as it is a government-appointed body with the power to play the role of a film editor, absurdities will continue. It is for this reason that the Shyam Benegal Committee in 2016 recommended that the CBFC’s powers to modify and change movies should be taken away and it should purely function as a certification body. Exactly what was needed. But it was also exactly what the government wouldn’t allow. And so, five years after that report, we still have a CBFC which is rubbing its hands to also edit OTT content. Moreover, the percentage of films without any cuts fell to its lowest levels over the last 100 years in 2016-17. And now, even the FCAT has been shut down. Clearly, film censorship is going in a direction opposite to what previous committees have recommended. So, is there a solution to this meta policyWTF?

Yes, turns out markets can help here. In 2016, my former colleagues Madhav, Adhip, Shikha, Siddarth, Devika and Guru wrote an interesting paper in which they recommended that film certification should be privatised.

Deploying the Banishing Bureaucracy framework, they wrote:

The CBFC be renamed the Indian Movie Authority (IMA) and that the primary purpose of the IMA would be to license and regulate private organisations called Independent Certifying Authorities (ICAs) which will then certify films.

The certificate granted by ICA will only restrict what age groups the film is appropriate for. This is the only form of pre-censorship that is necessary in today’s age as all other restrictions on film exhibition should be applied retrospectively. The choice of ICAs available for producers to approach will render the question of subjectivity moot as the producer can switch to another ICA if unsatisfied with the certificate. The IMA will set the guidelines for the ICAs to follow and will be the first point of appeal.

From Privatising Film Certification: Towards a Modern Film Rating Regime, Madhav Chandavarkar et al, Takshashila Discussion Document.

In other words, this solution reimagines the CBFC as a body that grants licenses to independent and private certification organisations called ICAs. These ICAs need to adhere to certain minimum threshold criteria set by the CBFC. Beyond these criteria, some ICAs may specialise themselves as being the sanskaari ones trigger-happy to award an “A” certification while others may choose to adopt a more liberal approach. In the authors’ words:

This will allow the marketplace of ideas to draw the lines of what kind of content is fit for what kind of audience with the government still being capable of stepping in to curb prurient sensibilities.

This solution has the added benefit of levelling the playing field between OTT content and films. Currently, the CBFC has no capacity to certify the content being churned out on tens of streaming services. By delegating this function to private ICAs, the government can ensure adherence to certification norms.

In essence. just as governments can often plug market failures, markets too can sometimes plug government failures. Reforming our ‘Censor Board’ requires giving markets a chance.

There’s a lot more detail in the paper about grievance redressal, certification guidelines, and appeals procedure. Read it here.

PS: A couple of days after the FCAT was shut down in India came the news that Italy on the other hand has abolished all film censorship and moved to a self-certification system instead. Saluti!

---

A Framework a Week:

Tools for thinking about public policy

— Pranay Kotasthane

Dr Yuen Yuen Ang is one of the most insightful writers on China’s economy. Her first book explained how China managed to escape poverty. Her second book, China’s Gilded Age: The Paradox of Economic Growth and Vast Corruption has a framework on corruption that’s relevant to us in India.

Created based on China’s Gilded Age: The Paradox of Economic Growth and Vast Corruption

The framework classifies government corruption on two axes — “who in the government engages in corruption?” and “does the money giver get anything in return?”. Four types of corruption result from this categorisation as shown above.

Ang claims that in most East Asian economies, the dominant mode of corruption is “access money” — bribes given to political elites with an explicit quid pro quo arrangement. On the other hand, the dominant mode of corruption in India is “speed money” — bribes given to low-level bureaucrats for property registration, a driving license, and so on. Though it intuitively sounds right, I take this result with heaps of salt as it is based on a survey measuring perceived corruption from the eyes of just 15 experts from the countries discussed.

Nevertheless, I found the framework interesting. A typology of corruption is a great idea. The book claims that with rising income levels, corruption doesn’t vanish but just gets institutionalised in the ‘access money’ quadrant.

To drive the point home, Ang connects these four types of corruption to four kinds of drugs. In her words:

“all corruption is bad – they are all drugs – but petty theft and grand theft are like toxic drugs [or drinking bleach, a term suggested by Jordan Schneider]; speed money is like painkillers; access money is like anabolic steroids – they help you grow rapidly but come with serious side effects that accumulate over time.

Access money functions as an incentive system for politicians and capitalists to work together, especially when massive infrastructure, involving huge sunk costs, is required for an emerging economy to take off. Access money overpays capitalists to do this, through cheap loans, subsidies, state backing, and in return you get feverish growth that lifts 700 million people out of poverty.”

That’s neat storytelling!

---

HomeWork

Reading and listening recommendations on public policy matters

1. [Article] Stewart Paterson’s white paper on the Hinrich Foundation site: The digital Yuan and China’s potential financial revolution.

2. [Article] Shyam Benegal on his tryst with CBFC. Money quote: ‘With Bhumika, there were no cuts, no obscenity. According to the censor guidelines, there was nothing that was transgressed, yet it was given an A certificate. I asked, why? They said, the subject of your film is adult.

---