UPI and the Cost of Policy Reversal

UPSC Syllabus: Gs Paper 3- Indian economy and Infrastructure

Introduction

Unified Payments Interface (UPI) transformed India’s shift from cash to digital payments, with zero Merchant Discount Rate (MDR) helping drive widespread merchant acceptance and financial inclusion. The Taxation and Other Laws (Amendment) Bill, 2026 now creates legal space for charges on specified electronic payment modes, reopening the debate over who should bear the cost of payment infrastructure. The policy shift raises concerns about UPI adoption, financial inclusion, market sustainability and investment in payment infrastructure.

Why Zero MDR Was Introduced and How It Transformed UPI

1. Shift towards a less-cash economy: Demonetisation in 2016 and UPI’s launch supported the government’s push towards greater use of electronic payments.
2. Zero-MDR mandate: In 2019, the government amended the Payment and Settlement Systems Act, making MDR zero from 1 January 2020.
3. Policy purpose: Zero MDR was a subsidy to move merchants and consumers away from cash and accelerate electronic payments.
4. Wider merchant acceptance: Free UPI payments encouraged merchants, including those avoiding cards because of fees, to accept QR-code-based payments.
5. Global scale: Since 2016, UPI has become the world’s largest real-time payments platform, accounting for nearly half of global real-time payments.
6. Rapid transaction growth: By early 2026, monthly UPI transactions crossed 21.7 billion, while transaction value exceeded ₹28.33 lakh crore, showing the massive scale of the ecosystem.
7. Financial inclusion: UPI brought informal payments into recorded digital trails, supporting formalisation, compliance and potential credit based on payment histories.

Who Should Bear the Cost?

1. Merchant as a cost bearer: In card payments, merchants traditionally pay MDR because accepting digital payments expands their customer base and can prevent lost sales.
2. Government as an alternative: The government can underwrite payment costs when digitalisation and economic formalisation are important policy goals.
3. Two-sided market problem: The party formally charged with MDR may differ from the party actually bearing it because banks and fintechs compete for merchants.
4. Pricing in competitive markets: Banks and fintechs cannot freely raise UPI prices because merchants can shift towards rival providers offering cheaper acceptance.
5. Cost absorption by intermediaries: Banks and payment service providers may absorb charges to retain merchants, leaving less room for investment and innovation.

The Hidden Costs of the Zero-MDR Model

1. Burden on banks: Government incentives covered only a fraction of UPI’s actual cost and were decided budget by budget, leaving banks with loss-making transactions and uncertain compensation.
2. Underinvestment in safeguards: Weak transaction economics reduced incentives to invest in fraud monitoring, dispute resolution, reliability and expansion into underserved segments.
3. Concentration among payment apps: Deep-pocketed Third-Party App Providers could absorb operational losses, helping two major players dominate the customer-facing market.
4. Network concentration: Zero MDR reduced the scope for competing payment networks, strengthening NPCI’s effective monopoly over payment infrastructure.
5. Systemic risk: Zero MDR delivered financial inclusion but also coincided with rising systemic fraud and severe market concentration.

The 2026 Policy Reversal: Restoring Economic Reality

1. Legal change: The Taxation and Other Laws (Amendment) Bill, 2026 amends Section 10A of the Payment and Settlement Systems Act, 2007, allowing charges on specified electronic payment modes.
2. Proposed MDR: The government proposes 0.25–0.5% MDR on UPI transactions above ₹2,000, covering about 5% of transactions by volume but nearly 65% by value.
3. End of statutory zero-MDR protection: The amendment reverses the legal framework that had kept MDR at zero for UPI and RuPay debit card transactions from 1 January 2020.
4. Pricing framework: The government can notify fee-bearing payment channels, while pricing decisions for notified modes move towards the NPCI steering committee.

Impact of the 2026 Policy Reversal

1. Burden of MDR: The charge may ultimately be borne by merchants, consumers, banks or payment service providers, depending on competition and their ability to pass on the cost.
2. UPI adoption: Even a small charge could change payment choices and reduce UPI usage, particularly when alternative payment systems are available.
3. Financial inclusion: Higher payment costs could weaken the digital transaction trail that supports formalisation, tax compliance and potential access to credit.
4. Payment ecosystem: If intermediaries absorb the cost, lower margins could reduce investment in reliability, fraud prevention and dispute resolution, while sustainable pricing could help address these weaknesses.
5. Market structure: The zero-MDR model contributed to concentration among major payment apps and strengthened NPCI’s position in payment infrastructure, creating concerns about competition and systemic dependence.

 Way Forward

1. Price payment infrastructure realistically: Digital transactions require funding for routing, settlement, fraud prevention, disputes and reliable service, so their costs cannot remain invisible.
2. Protect digital adoption: Any pricing model should avoid discouraging UPI use, especially among merchants and consumers who shifted from cash because payments were free.
3. Fund public policy goals transparently: If free transactions are retained for inclusion, the government should fully fund the underlying infrastructure instead of imposing uncertain support.
4. Preserve competition and innovation: Payment pricing should support sustainable investment by banks, payment providers and networks rather than encourage concentration.
5. Maintain policy consistency: A stable payments policy should avoid repeatedly changing incentives after users and merchants have adapted their behaviour.
6. Balance revenue with network effects: The government should avoid weakening UPI’s expanding digital ecosystem merely to raise revenue from electronic transactions.

Conclusion

The reversal of zero-MDR protection addresses the economic cost of maintaining UPI, but pricing must not weaken the digital payment ecosystem that the policy helped create. The focus should therefore be on sustainable payment infrastructure, continued UPI adoption, financial inclusion, competition and innovation. Any pricing framework should balance the real cost of payments with the wider economic benefits of digitalisation.

Question for practice:

Examine the need for reversing the zero-MDR policy for UPI and its potential impact on digital payments, financial inclusion and payment infrastructure.

Source: The Hindu