Reintroduction of Merchant Discount Rate

The Government of India is contemplating the reintroduction of the Merchant Discount Rate (MDR) on Unified Payments Interface (UPI) and RuPay debit card transactions for large merchants. This consideration arises after the removal of MDR in the Union Budget FY22, which aimed to promote digital payments. Currently, UPI and RuPay transactions are free for all merchants, but a tiered pricing model may soon be implemented, focusing on those with a GST turnover exceeding Rs 40 lakh.

About Merchant Discount Rate (MDR)

MDR is a fee charged to businesses by banks and payment service providers for processing digital transactions. It typically represents a small percentage of the transaction amount. This fee helps cover the costs associated with infrastructure and operational expenses related to digital payments.

Impact of MDR Removal

The elimination of MDR boosted UPI adoption across India. However, it also deprived banks, fintech firms, and payment service providers of important revenue stream. As government subsidies for digital payments diminished, there was increasing pressure from financial institutions to reinstate MDR, particularly for larger merchants.

Financial Support and Subsidies

To mitigate the loss incurred by removing MDR, the government initially allocated Rs 3,500 crore in subsidies to banks and payment companies. However, in the latest Union Budget, this amount was drastically reduced to Rs 437 crore. This reduction has raised concerns regarding the sustainability of UPI infrastructure and operations.

Growth of UPI Transactions

UPI has experienced remarkable growth over the years. Its share of India’s total payment volume surged from 34% in 2019 to an impressive 83% by the end of 2024. In 2018, UPI accounted for 375 crore transactions out of a total of 2,057 crore digital transactions. By 2024, UPI transactions skyrocketed to 17,221 crore, while the total digital payment volume reached 20,787 crore. The value of UPI transactions soared from Rs 5.86 lakh crore in 2018 to Rs 246.83 lakh crore in 2024, solidifying its position as the dominant payment method in India.

Consequences for Payment Companies

The absence of MDR on UPI transactions led to revenue losses for banks, fintech firms, and payment aggregators. This situation prompted companies to pivot towards alternative revenue models. These include subscription-based features, credit-linked UPI offerings, and value-added services to compensate for lost income.

Implications for the Payment Ecosystem

Reintroducing MDR for large merchants could restore a stable revenue stream for banks and payment service providers. This change may encourage further investments in digital payment infrastructure. Conversely, it could raise costs for businesses, potentially affecting their willingness to adopt digital payment methods. Smaller merchants may remain exempt from charges, ensuring continued accessibility to digital payments.

Questions for UPSC:

1. Critically analyse the impact of digital payment systems on the Indian economy.
2. What are the advantages and disadvantages of implementing a tiered Merchant Discount Rate model?
3. Explain the role of government subsidies in promoting digital payment infrastructure in India.
4. What are the challenges faced by fintech companies in India? How can these challenges be addressed?

Answer Hints:

1. Critically analyse the impact of digital payment systems on the Indian economy.

1. Digital payment systems have increased transaction efficiency, reducing cash handling costs.
2. They have boosted financial inclusion by providing access to banking services for the unbanked population.
3. UPI’s rapid growth has contributed to GDP by increasing consumer spending and business transactions.
4. However, reliance on digital systems poses risks like cybersecurity threats and digital fraud.
5. Regulatory measures are essential to protect consumers and ensure the stability of the financial system.

2. What are the advantages and disadvantages of implementing a tiered Merchant Discount Rate model?

1. Advantages include generating revenue for banks and payment providers, which can improve service quality.
2. A tiered model can promote fair competition by charging larger merchants while keeping smaller ones exempt.
3. It may encourage larger merchants to adopt better digital payment solutions due to associated costs.
4. Disadvantages include increased operational costs for large businesses, which may deter them from digital payment adoption.
5. It could lead to a fragmented market, where smaller businesses continue to benefit from free services while larger ones face charges.

3. Explain the role of government subsidies in promoting digital payment infrastructure in India.

1. Government subsidies help offset costs for banks and payment companies, encouraging them to invest in digital infrastructure.
2. Subsidies have historically supported the growth of UPI, making it a viable payment option for consumers and businesses.
3. They can stimulate innovation by providing financial support for developing new payment technologies.
4. Reduced subsidies can hinder growth, leading to lower investment in infrastructure and potential service quality decline.
5. Effective subsidy allocation is crucial for maintaining a sustainable digital payment ecosystem.

4. What are the challenges faced by fintech companies in India? How can these challenges be addressed?

1. Regulatory compliance is a major challenge, as fintech companies must navigate complex legal frameworks.
2. Access to funding can be limited, especially for startups, hindering their growth and innovation potential.
3. Competition from traditional banks and other fintech firms can create market saturation and pressure on profit margins.
4. To address these challenges, collaboration with regulators can encourage a supportive environment for innovation.
5. Developing partnerships with established financial institutions can enhance funding opportunities and market reach.