The Rise of Central Bank Digital Currencies (CBDCs) in the Middle East

The world is swiftly advancing towards a digital future, presenting both challenges and opportunities for central banks. The rapid evolution of digital technology, accelerated by the COVID-19 pandemic, is outpacing any other innovation in human history. The Middle East, known for its reliance on established financial systems , is now undergoing a remarkable transformation. The burgeoning popularity of central bank digital currencies (CBDCs) is reshaping the financial landscape, promising enhanced efficiency, inclusivity, and innovation.

In order to keep up with this trend and benefit from its considerable economic benefits, governments are implementing digitalisation policies to alter and improve the efficiency of public services. One issue arises as payments become more digitalised: could a structural transition from cash to digital currencies occur? Many central banks are considering how to fulfil their policy objectives in this shifting environment. Adopting a Central Bank Digital Currency (CBDC) is one way to keep central bank-issued money playing an essential role in a digital environment. A CBDC is a central bank's digital liability utilised as a payment method by individuals (retail) or financial organisations (wholesale). This article explores the swift adoption of CBDCs, with an emphasis on the UAE, Saudi Arabia, and other significant participants, as well as the future of digital currencies in the Middle East.

Concept and Importance of CBDCs

A Central Bank Digital Currency (CBDC) is a digital representation of a country's sovereign currency, issued and managed by the central bank. CBDCs, unlike decentralised cryptocurrencies like Bitcoin, are state-backed and considered legal money. CBDCs are intended to provide a secure, transparent, and efficient medium of exchange by utilising blockchain or other Distributed Ledger Technologies (DLT) to speed transactions and lower costs. As of June 2024, 130 countries, accounting for 98% of world GDP, were researching the potential use of a CBDC. This is consistent with information from country officials' public announcements. The majority of Middle Eastern and Central Asian countries interested in CBDCs are in the research stage, with a few in the proof-of-concept stage (Bahrain, Georgia, Saudi Arabia, and the UAE).

While there are no definitive economic conditions for implementing a CBDC, the decision to issue one is intricate and varies from country to country. Each nation has unique goals, payment and financial systems, legal and regulatory frameworks, and central bank capacity. CBDCs are a relatively new concept, with limited implementation and uptake, making it challenging to draw lessons from other nations. As a result, policymakers should approach the implementation of CBDCs with utmost caution, as it will require extensive analysis. Several factors are driving the Middle East's interest in CBDCs, including the increasing digitization of economies, the demand for more efficient cross-border payments, financial inclusion, and the need to maintain monetary policy control in a rapidly changing global economic landscape.

CBDCs provide numerous benefits over regular cash and digital payments, including:

- Efficiency: CBDCs can simplify transactions, lowering costs and settlement times.

- Inclusivity: They can provide financial services to underserved communities, boosting economic growth.

- CBDCs can help develop innovative financial products and services.

UAE’s Role in CBDC Adoption

The UAE has emerged as a regional pioneer in the adoption and exploration of CBDCs. Its ambition to become a global hub for blockchain and financial innovation is deeply embedded in its 'UAE Blockchain Strategy' and larger initiatives towards digital transformation. In 2023, the UAE Central Bank announced significant progress in its CBDC initiative, the 'Digital Dirham'. This initiative is part of a broader effort to integrate innovative financial technology into the UAE's banking and payment systems, thereby enhancing efficiency, security, and transparency. The UAE has actively collaborated with other countries and financial institutions on its CBDC journey, including the 'Aber Project' with Saudi Arabia's central bank, the Saudi Arabian Monetary Authority (SAMA).

The Aber Project aimed to investigate the potential of employing a dual-issued CBDC for cross-border transactions between the two countries. This experiment highlighted CBDCs' ability to drastically reduce the time and costs involved with cross-border payments, a significant concern for Middle Eastern countries due to the volume of remittances and international trade. The UAE has also sought partnerships with global organisations such as the Bank for International Settlements (BIS) and Asian central banks to test cross-border CBDC frameworks. As one of the region's most significant financial hubs, Dubai is particularly interested in incorporating CBDCs into its financial ecosystem, which is consistent with its overall policy of embracing blockchain, fintech, and artificial intelligence.

The GCC region has the highest asset concentration. Large banks dominate the banking system in all six GCC nations, with the top four accounting for approximately 70% (Saudi Arabia) to 88% of total assets. In comparison, bank concentration in MENAP is similar to the global emerging market average, accounting for approximately 62% of system assets in 2021.

Saudi Arabia's Vision of CBDCs

Saudi Arabia, the Middle East's largest economy, has also played an important role in the region's CBDC exploration. The Saudi government has made significant investments in financial technology and digital innovation as part of its Vision 2030 strategy to diversify the economy and lessen reliance on oil. The Aber Project with the UAE was a significant milestone that demonstrated Saudi Arabia's commitment to digital currency experimentation. Furthermore, in 2023, the Saudi Central Bank (SAMA) began an additional investigation into the viability of establishing a Saudi CBDC for both retail and wholesale transactions.

Saudi Arabia's interest in CBDCs goes beyond internal efficiency. The country also wants to boost its place in the global financial system by modernising payment infrastructure and improving cross-border trade capabilities. Establishing a CBDC in Saudi Arabia would also be consistent with its larger push for digital banking and financial inclusion. The kingdom has one of the world's highest smartphone penetration rates, and digital banking services are increasingly popular. A CBDC might enable smooth digital payments, accelerating the country's ambition to be a cashless society.

Other Middle Eastern Initiatives

In addition to the UAE and Saudi Arabia, additional Middle Eastern countries are looking into CBDCs.

Bahrain, a financial powerhouse with a strong emphasis on fintech innovation, has expressed an interest in CBDCs to help improve its banking and payment systems. The Bahrain Central Bank has been experimenting with blockchain technologies and is interested in learning more about CBDCs' role in boosting financial inclusion and cross-border payments.

Despite being a minor market, Qatar has expressed interest in CBDCs, particularly in remittances and trade finance. With a sizable expatriate community and extensive international trade activity, implementing a CBDC could alleviate critical inefficiencies in Qatar's financial system.

Oman and Kuwait are also conducting preliminary studies on CBDCs, recognising the potential economic benefits. Both countries have made investments in digital infrastructure and financial innovation, positioning themselves to profit from CBDC adoption.

Future of CBDCs in the Middle East

As these digital currencies acquire acceptance, they may significantly impact the region's financial infrastructure. The potential benefits include increased financial inclusion by providing access to financial services to those currently excluded from regular banking. CBDCs can also improve cross-border payments by simplifying international transactions, cutting costs and increasing efficiency. It can also stimulate innovation in the financial sector, resulting in new products and services.

The UAE's position as a financial and technological leader in the area is likely to have a considerable impact on how CBDCs are developed and implemented throughout the Middle East. Dubai and Abu Dhabi, in particular, are primed to become major hubs for digital currency innovation, attracting international investment and collaboration. However, some issues remain. Regulatory frameworks, interoperability between CBDCs from different countries, and cybersecurity issues must all be handled appropriately. Central banks must also strike a balance between driving innovation and ensuring financial stability.

Conclusion

As the Middle East continues to embrace digital technologies, CBDCs are poised to play a pivotal role in shaping the region's future. By carefully navigating the opportunities and challenges, countries in the Middle East can harness the power of CBDCs to drive economic growth, enhance financial inclusion, and foster innovation.

References –

International Monetary Fund - https://www.imf.org/en/Blogs/Articles/2024/06/18/central-bank-digital-currencies-can-boost-middle-easts-financial-inclusion-payment-efficiency

Middle East Council on Global Affairs - https://mecouncil.org/blog_posts/central-bank-digital-currencies-impact-on-mena-economies-council-views/

Deloitte - https://www.deloitte.com/middle-east/en/services/risk-advisory/perspectives/central-banks-digital-currencies.html

World Economic Forum - https://www.weforum.org/open-forum/event_sessions/open-forum-the-digital-currencies-opportunity-in-the-middle-east/