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

22 October 2021 Brian Lawson

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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