In a world rapidly evolving towards a digital future, the role of Central Bank-issued Digital Currencies (CBDCs) is gaining prominence. As we explore this groundbreaking development, it is essential to consider the impact, potential opportunities, and challenges that CBDCs present.

The Unbanked Population: A Critical Concern

Pakistan, like many other countries, faces a significant challenge with a substantial unbanked population. Shockingly, only 21%[1] of adults in the country have access to formal financial services. The reasons for this disparity are multifaceted, including geographical remoteness, low literacy rates, inadequate infrastructure, religious considerations, and a pervasive avoidance of taxes.

CBDC: A Lifeline for the Unbanked

The introduction of CBDCs holds the promise of extending a financial lifeline to these underserved individuals. Digital wallets are poised to play a pivotal role in bridging the accessibility gap to financial services, revolutionizing the way people engage with money. This digital leap has the potential to dramatically reduce cash usage, enhancing overall transaction efficiency and transparency.

Addressing the Undocumented Economy

One of the root causes of many financial problems in Pakistan is the undocumented economy. A substantial portion of economic activities is conducted in cash, with the informal sector predominantly paying their employees in cash. Moreover, the hoarding of cash has become a growing phenomenon, both among businesses and households.

The immediate positive impact of digital currency lies in bringing economic activity out of the shadows and into the realm of documentation and taxation. Unlike cash, digital currency transactions are always traceable, making it exceedingly difficult to conceal any financial activity. This enhanced transparency could play a pivotal role in stabilizing economic conditions in the country.

CBDCs and Digital Identity

CBDCs introduce a unique opportunity in Pakistan due to its state-of-art NADRA identity. CDBC through establishing a link between a user's digital identity and the device they use for transactions is essential for security and trust in digital payment systems. By linking a person's unique digital identity to their CBDC wallet, the central bank can authenticate their identity, ensuring that transactions are secure and trustworthy.

Access to Financial Services

One of the most significant obstacles to financial inclusion is the lack of access to traditional banking services. Many individuals are excluded from these services due to their remote locations or the complex onboarding processes required by the banks. CBDCs, by enabling transactions on mobile phones, can provide a pathway to the formal financial system without the necessity of a physical bank account. This extends financial services to the unbanked and underbanked populations, fostering financial inclusion.

Enhanced Security

CBDC transactions are more secure due to the integration of digital identity and device authentication. This heightened security minimizes the risk of identity theft and fraud, instilling trust in the system. As a result, individuals are more likely to adopt CBDC and engage in digital financial transactions.

New Business Models

CBDCs will enable households to establish a financial history. This not only will benefit consumers but will also create a digital record of valuable financial information, which could be used by businesses and new entrants to develop and introduce new products and services to the unbanked.

The Promise of CBDC for Pakistan

In the case of Pakistan, CBDC offer numerous advantages, including:

• Improved Payment Systems: CBDCs are set to improve payment systems by providing faster and cheaper transactions, reducing the frictions and costs associated with physical cash storage.
• Increased Efficiency: CBDCs aim to reduce the need for intermediaries in the payment process, lowering transaction costs and increasing speed. They will also optimize cross-border transaction settlement processes.
• Enhanced Monetary Policy: CBDCs provide central banks with better control over monetary policy, allowing for more direct control over money supply and velocity. This grants them visibility over payment flows, enabling more effective policy implementation.

Seizing Opportunities

Despite an increase in financial inclusion, there is still a long way to go, as evidenced by the 30%[2] inclusion rate reported in Pakistan in 2022. Digital currency pledges a faster, more economical, and streamlined future of payment transactions. Pakistan can leverage CBDC development to serve a greater number of unbanked customers, particularly the young and tech-savvy population, along with IT-skilled talent. NADRA's unique identity number, required for various official documents, will play a crucial role in the success of CBDC.

The State Bank of Pakistan's move towards a comprehensive Digital Financial Services (DFS) framework, including regulations for electronic money institutions, digital onboarding, and more, will pave the way for CBDC.

Digital Financial Inclusion: Strong Use Case for CBDCs

To harness the full potential of digital currency, institutional capacity must be improved, talent and expertise allocated, financial and digital literacy broadened, and stakeholder communication enhanced to reach the masses.

The government can disburse cash for social safety programs, salaries, grants, pensions, etc., through CBDC. Additionally, creating a favorable ecosystem for digital payments at government-run institutions can further promote CBDC usage.

Some recommendations for a successful CBDC implementation include:

• No Bank Account Requirement: Access to CDBC without a bank account.
• Ease of Use: Streamlined processes with minimal fees.
• Offline Payments: Support for offline transactions without the need for smartphones.
• Interoperability: Compatibility with other digital channels.
• Ecosystem Development: Encouraging usage and acceptance at various points.
• Rewards: Incentives for using CBDC.
• Easy Conversion: Smooth transition to and from cash.
• Awareness and Literacy Programs: Educating the public, especially in rural areas.
• Efficient Settlement and Complaint Management: To ensure greater user experience.

Central Bank-issued Digital Currencies are reshaping the financial landscape around the world. Their potential for financial inclusion, improved payment systems, and enhanced monetary policy makes them a promising solution. Nevertheless, challenges such as cybersecurity, infrastructure, user education, and privacy concerns must be addressed for a successful implementation. By seizing these opportunities and overcoming setbacks, CBDCs can truly be a game-changer in the financial world.

[1] World Bank's Findex

[2] https://portal.karandaaz.com.pk/dataset/financial-digital-inclusion/1038