Destabilizing effect  of crypto on fiscal and monetary policy

  • July 19, 2022
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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Destabilizing effect  of crypto on fiscal and monetary policy

Subject :Economy

Section: Fiscal Policy

Context:

There should be an international collaboration to make crypto prohibition law effective in the country, according to Finance Minister Nirmala Sitharaman.

Why?

Cryptocurrencies  have a destabilizing effect on the monetary and fiscal stability of a country according to the RBI.

How?

  • Acceptability-Such digital currency may not be accepted as a medium of exchange, store of value or a unit of account — essentially de-recognising the three key functions of money.
  • Sovereign guarantee-Cryptocurrencies pose risks to consumers as they are  not a fiat currency.
  • Market volatility-
    • The value of fiat currencies is anchored by monetary policy and their status as legal tender
    • The value of cryptocurrencies however,rests solely on the speculations and expectations of high returns that are not well anchored, so it will have a de-stabilising effect on the monetary and fiscal stability of a country.
    •  For instance, the value of Bitcoin fell from USD 20,000 in December 2017 to USD 3,800 in November 2018.
  • Money laundering-Cryptocurrencies are more vulnerable to criminal activity and money laundering.
    • They provide greater anonymity than other payment methods since the public keys engaging in a transaction cannot be directly linked to an individual.
  • Regulatory bypass: A central bank cannot regulate the supply of cryptocurrencies in the economy.  This could pose a risk to the financial stability of the country if their use becomes widespread. It will make monetary policy transmission difficult. 
  • Weaken central bank’s control over money supply-When the crypto is introduced, other governmental departments such as IT and telecom will need to be involved for its smooth functioning. This may, initially at least, create coordination and implementation issues.
    • Further currencies outside RBI’s regulatory regime would have inflationary effects.
  • Destabilise Financial sector-Digital currency assets could weigh heavily on the business of commercial banks, which have for long been acting as the financial intermediary, assisting in India’s economic growth.
    • The deposit base of the financial sector  will erode. This could result in lending rates going up, leading to rise in borrowing costs.
  • Uncertainty in financial markets-Many public sector and private banks have been hit by a huge number of fraudulent transactions. The situation could worsen when there is an increasing shift to digital currencies without having proper regulation.

Status of Cryptocurrencies:

  • In 2018, the RBI has prohibited its regulated entities to deal in virtual currencies or provide services for facilitating any person or entity in dealing with or settling VCs.
  • The RBI’s ban was, however, set aside by the Supreme Court on March 4, 2020.
  • The RBI through a circular,advised its regulated entities to continue to carry out customer due diligence processes for transactions in VCs, in line with regulations governing standards for Know Your Customer (KYC), Anti-Money Laundering (AML), Combating of Financing of Terrorism (CFT), Prevention of Money Laundering Act (PMLA), 2002,Foreign Exchange Management Act (FEMA) etc.
  • Finally, Cryptocurrencies, though unregulated, are not illegal in India.
Fiat money

  • It is not backed by physical commodities, such as gold.
  • It is government-backed money. 
  • Most paper currencies today are fiat currencies.
  • Fiat money value is based on the relationship between supply and demand. Fiat holds value because of people’s faith in that nation’s currency.
  • In the past, governments minted coins or paper money tied to the value of a physical commodity, which could then be redeemed for a set amount of that commodity. Fiat money cannot be redeemed. 
  • It gives central banks greater control over the economy, as they can control how much money is printed. Inflation may occur when a government creates too much of a fiat currency, and the money supply increases too rapidly as a result. Governments printing too much money can create hyperinflation.

Legal Tender 

  • Legal tender is any form of payment recognized by a government, used to pay debts or financial obligations, such as tax payments. 
  • National currencies, such as the U.S. dollar, are legal tender.
  • Notably, cheques and credit cards aren’t legal tender—rather, they are money substitutes.
  • Legal Tender is a coin or a banknote that is legally tenderable for discharge of debt or obligation.
  • India-The coins issued by Government of India under Section 6 of The Coinage Act, 2011, shall be legal tender in payment or on account provided that a coin has not been defaced and has not lost weight so as to be less than such weight as may be prescribed in its case.
    • Limited legal tender-Coin of any denomination not lower than one rupee shall be legal tender for any sum not exceeding one thousand rupees.
    • Fifty paise (half rupee) coins shall be legal tender for any sum not exceeding ten rupees.
    • It means anyone cannot be forced to accept coins beyond the limits mentioned above, voluntarily accepting coins for amounts exceeding the limits mentioned above is not prohibited.
    • Unlimited legal tender-Currency notes are unlimited legal tender and can be offered as payment for dues of any size.
    • Every banknote issued by Reserve Bank of India (Rs2, Rs5, Rs10, Rs20, Rs50, Rs100, Rs200, Rs500 and Rs2000), unless withdrawn from circulation, shall be legal tender at any place in India in payment or on account for the amount expressed therein, and shall be guaranteed by the Central Government, subject to provisions of sub-section (2) Section 26 of RBI Act, 1934.
    • Rs1 notes issued by Government of India are also Legal Tender.
Destabilizing effect  of crypto on fiscal and monetary policy economy