Small levy on UPI transactions, not a bad idea

UPSC Syllabus: Gs Paper 3- Indian economy and Infrastructure

Introduction

Unified Payments Interface (UPI) has become a core part of India’s digital payments system, but rapid growth has raised costs for banks, processors and Payments Corporation of India (NPCI). The proposed legal change allowing Merchant Discount Rate (MDR) raises a basic question: how can UPI remain affordable while creating a sustainable revenue model? A carefully designed levy can meet funding needs without hurting small-value transactions, financial inclusion, or UPI’s continued adoption across India over the long term as digital payment adoption continues to expand nationally.

UPI’s Rapid Growth and the Rising Cost of Its Ecosystem

1. Global scale: Since 2016, UPI has become the world’s largest real-time payments platform, accounting for nearly half of global real-time payments.
2. Rapid transaction growth: By early 2026, monthly transactions crossed 21.7 billion and transaction value exceeded ₹28.33 lakh crore, increasing ecosystem costs.
3. Rising operating costs: Banks and payment providers bear growing expenses for servers, security, fraud prevention and system maintenance as UPI expands.
4. Large funding gap: Industry estimates put annual operational costs near ₹20,000 crore, while government incentives cover only around 11% of actual costs.
5. Limited government support: Allocations have fluctuated from ₹2,485 crore in FY24 to ₹1,146 crore in FY25, before rising to ₹2,200 crore in FY26 and ₹2,000 crore in FY27.
6. Need for cost sharing: The funding gap shows that continued dependence on government support alone may not adequately sustain UPI’s infrastructure and future investment needs.

Why UPI Needs a Sustainable Revenue Model

1. UPI ecosystem needs revenue: The National Payments Corporation of India operates and maintains UPI, while payment processors and third-party application providers need revenue to sustain the growing payment ecosystem.
2. Large funding gap: UPI’s annual operational costs are estimated at nearly ₹20,000 crore, while government incentives cover only around 11% of actual costs and about 14% of MDR revenue forgone.
3. Government support has limits: The Centre spent ₹2,196 crore in FY26 and budgeted ₹2,000 crore for FY27, but such support cannot fully meet the ecosystem’s operational and investment needs.
4. Zero-MDR puts pressure on public finances: The Parliamentary Standing Committee linked the zero-MDR regime with pressure on government finances and limited capacity for long-term infrastructure investment.
5. Cost recovery has a precedent: National Electronic Funds Transfer (NEFT) and Real-Time Gross Settlement (RTGS) recover charges through transaction-value bands, while debit and credit cards already carry Merchant Discount Rate (MDR).
6. Other digital modes already carry MDR: RuPay Credit Card on UPI and Prepaid Payment Instrument (PPI) wallet transactions can also attract MDR, showing that zero charges need not apply to every digital payment mode.

Protecting Small-Value Transactions and Financial Inclusion

1. Small payments dominate: Transactions below ₹500 account for 86% of UPI volume, while payments between ₹500 and ₹2,000 contribute another 10%.
2. Broad exemption is possible: Applying MDR only above ₹2,000 would exempt 96% of Person-to-Merchant (P2M) transactions, protecting most everyday users from additional charges.
3. Small merchants need protection: Small kirana stores and low-ticket purchases account for over 80% of transaction volume, making them more vulnerable to even small additional charges.
4. Even a small fee may affect adoption: A 0.1% fee could push some small vendors towards cash, potentially reversing progress in formalising the economy.
5. Financial inclusion supports exemption: With India’s Financial Inclusion Index at 67%, low-value transactions should remain free to avoid adding costs for less affluent users.
6. Higher-value transactions can be treated differently: Large commercial users processing thousands of transactions daily can bear a nominal MDR without facing the same affordability concerns as small merchants and users

Way Forward

1. Adopt value-based MDR: Charges should be banded by transaction value, with low-value payments exempt and higher-value commercial transactions carrying a nominal levy.
2. Keep ₹2,000 as a threshold: Making transactions above ₹2,000 liable can preserve free access for 96% of Person-to-Merchant (P2M) transaction volume.
3. Target organised commercial users: MDR should focus on larger merchants rather than small kirana stores and routine low-ticket purchases, which remain sensitive to added costs.
4. Delay implementation until scale deepens: UPI’s user base could double from 50 crore, while transaction growth has slowed from its early pace.
5. Consider adoption maturity: MDR should begin after UPI reaches irreversible scale, because user growth and transactions per user still have room to expand.
6. Use existing payment models: The design can follow NEFT and RTGS by linking charges to transaction value rather than imposing a uniform fee.
7. Reduce permanent subsidy dependence: A viable revenue mechanism can lessen pressure on the government exchequer while helping the ecosystem fund its own upkeep.
8. Balance sustainability with inclusion: The final design should recover costs from users who can bear them while keeping everyday small-value payments free.

Conclusion

A small, targeted UPI levy can improve ecosystem sustainability without weakening financial inclusion. The best approach is to exempt low-value payments and impose nominal, value-based MDR on higher-value commercial transactions. This can reduce pressure on public finances, support future infrastructure, and give NPCI and payment processors a viable revenue base while keeping digital payments accessible to users.

Question for practice:

Evaluate whether a targeted Merchant Discount Rate (MDR) on high-value UPI transactions can ensure financial sustainability without harming financial inclusion.

Source: Businessline