By: Esteban Medina
El Salvador’s President Nayib Bukele’s June 2021 announcement to accept Bitcoin as legal tender in the country sparked debate about the potential ramifications the endeavor could have on the country’s financial stability and economic conditions. President Bukele has argued that the widespread implementation of the cryptocurrency could improve the country’s low banking penetration rate and lower remittance costs. However, Bitcoin’s high price volatility has led international organizations, such as the International Monetary Fund (IMF), as well as El Salvador’s own citizens, to question the move. Instead of focusing on a decentralized, privately issued digital currency, such as Bitcoin, Less Economically Developed Countries (LEDCs) could benefit from an alternative form of cryptocurrency that satisfies both President Bukele’s and his critics’ concerns: central bank digital currencies (CBDCs).
CBDCs are a digital form of a country’s currency that are issued and regulated by the nation’s central bank, and thus can have lower price volatility than that among other forms of cryptocurrency. The two major variations of CBDC prototypes are wholesale and retail. Retail CBDCs will be of particular focus due to their direct accessibility to the general public, while wholesale CBDCs involve a financial intermediary. Because of their theoretically high level of accessibility, CBDCs have the potential to shift international monetary policy and play a major role in economic development.
Proponents of CBDCs in emerging economies often specify the tool’s likely contributions to financial inclusion. According to the World Bank, an estimated 1.7 billion adults lack access to traditional financial services. Despite this, about two-thirds of these unbanked individuals have access to a mobile phone. In an increasingly digitized ecosystem, CBDCs have the ability to tackle long-established barriers to accessing financial services. Individuals seeking to create a digital wallet simply need proof of identification, a mobile device, and access to an internet connection. Thus, the nature of retail CBDCs eliminates lengthy approval processes and costly travel to physical banks for those living in rural areas. High overhead fees, associated with regulation and money storage, are also eliminated, making financial services more cost-effective. CBDCs additionally allow unbanked individuals the opportunity to build credit and a financial history—a lack of which have been hurdles for poor communities seeking services offered by traditional banks.
Increasing banking penetration rates has been a critical goal for countries seeking to promote economic growth domestically. Financial inclusion enables people to step out of poverty, and improved saving rates resulting from financial inclusion can be a critical driver of long-term economic growth, encouraging later investments in businesses, education, and physical capital.
Similarly, CBDCs could lower the cost of remittances, the largest source of external financing in LEDCs. Remittances, on average, cost 7%. This is twice the target rate set by the United Nations Sustainable Development Goals. Furthermore, banks providing access to cross-border payments have fallen by 22% since 2011. The design of CBDCs would solve both these complications by lowering transaction costs and increasing accessibility, thus ensuring more efficient international capital flow.
Monetary and fiscal policy could also be considerably improved following implementation of the digital currency, further facilitating economic growth. In terms of monetary policy, an interest-bearing CBDC proves to be a powerful instrument granting central banks the ability to easily execute decisions regarding interest rates. Similarly, the widespread use of CBDCs could enhance the direct engagement between a country’s central bank and its citizens. This improves the efficacy of stimulus programs by reducing the costs and time associated with cash transfers. Utilizing this instrument also improves fiscal transparency and can allow for increased monitoring, therein discouraging tax evasion and avoidance, money laundering, and other illegal activities that have hampered economic development.
Of course, most of these outcomes rely on both optimistic assumptions and the optimal design of a digital currency. For example, the effects outlined assume a population with internet access; however, only about 60% of the world has access to an internet connection. Likewise, it is assumed that the population has trust in its government and financial institutions, yet many LEDCs suffer from widespread mistrust due to corruption and weak institutions. An inefficient design of a country’s CBDC could also lead to currency substitution and bank runs, resulting in a reduced ability for governments to maintain control of their fiscal and monetary policy.
With these assumptions and limitations in mind, CBDCs still prove to be a highly versatile instrument for policymakers in developing nations. Although global, truly universal internet access is unlikely anytime soon, digital infrastructure is growing at an unprecedented pace, making CBDCs increasingly more plausible. Eighty-six percent of central banks are also reported to be engaging in research involving CBDCs in an attempt to construct an optimal design. As the world becomes more digitized and policymakers invest more resources into the development of CBDCs, this tool could create a more efficient, secure, accessible, and faster financial and monetary system—both in the developing world and beyond.