Sustainable Digital Rail: Rebalancing the Economics of Zero-MDR on UPI
UPI in India has come to be one of the most critical instances of digital public infrastructure in the world. This is the payment platform that has revolutionized Indian payment systems for even trivial tasks, from buying a cup of tea to paying university fees and taking a taxi. The remarkable success of the system is, to a great extent, because of the following idea: UPI digital payments must always be affordable and accessible.
There is an urgent question that India must address. Is it possible to have a payment ecosystem of such a scale, where the basic transaction does not involve any Merchant Discount Rate, or MDR?
It is not necessary to choose between two alternatives: consumer fees or zero cost for the merchant. What is much more important is to design a different economic model for UPI to ensure that the payment system remains affordable for users and profitable for those who run it.
Zero-MDR Helped Build the Digital Payments Habit
Zero MDR for UPI transactions was a significant factor contributing to its rapid uptake. The elimination of the transaction fee for small merchants diminished their reservations about using digital payments. From the consumers’ perspective, the absence of a fee made UPI transactions almost invisible – open the application, scan a QR code, and make a payment.
This feature of UPI turned out to be among its most effective.
There is no need for a small merchant to consider the cost of payment processing each time a customer uses a QR code. There is no need for a consumer to evaluate whether it makes sense to use UPI for a particular transaction from a fee perspective. The process of making digital payments becomes a default mode.
However, the issue is that zero price at the moment of transaction does not equal zero cost for the entire system.
Banks need to provide payment infrastructure; payment service providers need technology, cyber-security, and customer support services. Fraud-monitoring systems require constant investments; NPCI requires resources for maintaining and upgrading the infrastructure. Merchants and customers expect transactions to be available 24/7, settled instantly, and without failure.
Scale Changes the Economics
This can hardly be true of a payment network that operates at a billion transactions level relative to a small card network or specialized digital wallet.
On such scale, any revenue from each transaction might become relevant. On the contrary, in case when there is no MDR revenue from each transaction, other sources of financing should be used.
The system can sustain itself through this period of development when the players involved are ready to invest for strategic considerations. However, in case of UPI which becomes a part of India’s infrastructure, sustainability should become a goal next to the goal of affordability.
It becomes especially relevant in case when digital payments systems shift beyond P2P and become used for commerce, subscription, credit products, finance and business payments.
The Real Question Is Not “Should UPI Have MDR?”
This decision is commonly seen in black-and-white terms as a decision of whether to maintain zero MDR or impose a charge.
This is a simplistic view of the problem.
Instead, we should be asking ourselves what aspects of the UPI eco-system truly require zero MDR, and what alternatives could work based on the economics of the situation without deterring adoption?
For instance, does the economics of a street vendor who processes ₹50 payments using UPI have the same considerations as that of a large enterprise processing several thousand transactions per day?
Similarly, the purpose of money transfer to a relative differs from the intent of money transfer to a business entity.
A one-size-fits-all solution may thus prove to be increasingly redundant as the system evolves.
Small Merchants Need Protection
The issue of reforming the economics of the Unified Payments Interface (UPI) cannot be addressed without taking a look at the micro enterprises in India.
For many merchants, especially the smaller ones who operate on razor-thin margins, even a small payment processing charge can mean a lot. Implementing an MDR policy on a broad front can drive away merchants from using digital channels, or at worst, result in increased transaction costs being passed on to the consumer.
This will be detrimental to one of the biggest achievements of UPI socially and economically.
A viable solution, in this case, would be to separate the economics of digital inclusion from those of payment processing.
Smaller value transactions and smaller merchants can continue to receive strong protection, while larger payment transactions could contribute towards infrastructure cost.
Who Should Pay for the Infrastructure?
This is when the story gets interesting.
Nowadays, the value created by the UPI ecosystem goes far beyond the payment itself. Financial products could be created by banks and financial technologies around transaction relations. The merchants get customer convenience and possibly increased visibility of the business. Payments could become an entry point into financial services from the platform side.
In case of non-existent revenues generated by the payment itself, there will likely be attempts of recovering the expenses on the adjacent products.
This could lead to its own issues.
A system where the basic payment infrastructure is subsidised by cross-selling financial products could develop commercial incentives that are not always consumer-friendly.
An open economy would be better than excessive dependence on indirect monetization.
Government Support Cannot Be the Only Long-Term Answer
Fiscal incentives have been driving the adoption of digital payments, and fiscal investments in the development of digital infrastructure are legitimate in light of the fact that UPI brings about general economic advantages.
However, permanent reliance on fiscal support entails an additional issue: what will happen if transaction volumes grow at a faster pace than the funding mechanism?
Since UPI plays an increasingly important role in transactions, its economics should be stable in the future.
Public spending can go on contributing to strategic goals like financial inclusion and micro-transactions. However, there must also be ways for the commercial infrastructure to recover its costs.
It need not necessarily mean that consumers would have to bear the cost each time they scan a QR code.
Security Is Becoming a Bigger Cost
The coming stage of UPI will demand much more investment in cybersecurity.
Payment fraud is getting more advanced. Social engineering, fraudulent customer service centers, phishing, attempts at account takeover, as well as growing use of artificial intelligence, present threats to consumers, merchants and banks.
Sustaining trust in an instant payment system calls for perpetual investments in authentication, fraud detection, monitoring, and dispute resolution.
This is no additional cost.
For India to continue relying on UPI as the basis of its digital economy, the economics of the system should be such that security becomes part of its operation rather than technology upgrades.
UPI Has Become Digital Public Infrastructure
The most critical change, perhaps, is conceptual.
UPI must stop being perceived simply as yet another payment solution trying to compete against credit cards or cash.
It has transformed into a component of India’s digital economy infrastructure.
This raises the issue of sustainability beyond MDR.
It must be ensured that the qualities which made UPI such a success remain intact – namely accessibility, interoperability, speed and low friction – while at the same time making sure that the entities which manage UPI keep on investing.
This requires a much more nuanced discussion.
A Sustainable Model Can Preserve Zero-Cost Access
There is no natural conflict between having the UPI available and having better economics of it.
India could experiment with approaches whereby the smallest merchants and small payments are safeguarded, but large commercial payments or businesses which derive considerable economic benefits from payment systems infrastructure pay for it appropriately.
The specific design would need careful thought and evidence-based consideration. The modification process must be transparent and foreseeable, and must not just pass on hidden costs to the consumers.
The basic idea is simple: safeguarding inclusion, paying for value creation properly, and financing infrastructure sustainably.
Conclusion
India is not faced with having to make a choice between UPI usage and payment system sustainability.
The brilliance of zero MDR for the UPI was in taking the friction out of payments at exactly the time when India required consumers and businesses to adopt digital payments. However, once you succeed, the question changes.
The next step in the evolution of the UPI would not be to reverse course on zero cost digital payments but to create an economic model to sustain them.
India built the railway for payments without friction. The next step is to ensure that the railway itself is sustainable.
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