The introduction of India's Unified Payments Interface (UPI) has changed the face of the country's payment system by providing millions of people with the ability to carry out real-time, interoperable and secure digital transactions.

Since it was launched in 2016, UPI has developed into one of the largest real-time payment systems in the world and now forms a key part of India's digital public infrastructure. A major factor in this success has been the policy of zero merchant transaction fees on UPI transactions which made digital payments affordable for both businesses and consumers. The number of transactions that UPI handles each month now exceeds 18 billion and represents a major portion of retail digital transactions in India, which shows the extent and impact of the digital payments revolution in the country. 

Understanding the UPI Zero MDR policy

The Government's choice was to abolish the UPI merchant discount rate (MDR) which had previously been applied to merchant transactions carried out via UPI. Traditionally, the MDR is a charge paid by merchants to banks or payment service providers when they accept digital payments. Before 2020, it was possible to charge MDR on transactions made by merchants. However, to encourage the use of digital payments and to promote financial inclusion, the government set the MDR at zero for BHIM-UPI and RuPay debit card transactions. This policy meant that merchants, in particular small businesses and micro-enterprises, could take digital payments without having to pay extra. At the same time, the government set up an incentive scheme in order to support various participants in the ecosystem and to ensure that the digital payment infrastructure remained viable. 

The impact of P2M transactions on UPI growth has been significant, with a CAGR of 50.67% over the past three years, compared to 32.48% for P2P transactions. Introducing MDR on UPI transactions at this stage could hinder this momentum, particularly among merchants, by increasing their cost burden and discouraging adoption.

How Zero MDR transformed digital payments in India, accelerating UPI merchant adoption

By getting rid of the fees that UPI charged merchants for transactions, a major obstacle to the acceptance of digital payments was removed. As a result, small retailers, local stores, street vendors and micro-enterprises quickly took up QR-code payment systems, which led to a widespread expansion of digital transactions in both urban and rural areas of India. Currently there are over five crore merchants who accept digital payments, and UPI has been a major factor in promoting their adoption. The increase in person-to-merchant (P2M) transactions shows what this shift involves. Since merchant payments have grown at a faster rate than peer-to-peer transactions, it is clear that digital payments are now being widely accepted in ordinary commerce. Driving the growth of the UPI payment ecosystem, the Indian UPI digital payment system has succeeded because of the combination of interoperability, security, scalability and no cost for access. Since UPI has an open architecture, it is possible to carry out transactions between banks, fintech platforms and payment applications, which in turn promotes innovation and competition as well as ensures smooth customer experiences. The Zero MDR policy in India has strengthened these benefits by keeping participation costs low and encouraging widespread acceptance among both consumers and merchants.

UPI and financial inclusion: A catalyst for inclusive growth 

Making digital payments accessible for all concerning UPI transactions has been crucial to expanding access to financial services since it removed transaction fees, making UPI an affordable means of payment for low-income households, rural consumers and small merchants. As a result, the shift from cash to digital payments has been sped up and millions have been brought into the formal financial system. Adoption in rural areas has increased greatly, since rural users nowadays tend to choose UPI over cash, which is a sign of evolving consumer behaviour and of growing confidence in digital payments.

Growth of Financial Inclusion Index by RBI

Digital public infrastructure of India

The growth of UPI is closely linked to improvements in the financial inclusion indicators of India; as the payment infrastructure becomes free and more accessible, people who have previously been excluded from formal finance are now able to take a more active part in the financial system, and the rise in the RBI's Financial Inclusion Index is a reflection of this advancement. Since it allows users to create a digital record of their transactions, UPI also enables access to formal credit, insurance and other financial products. This digital record is especially useful for people who are borrowing for the first time and for those who are involved in the informal sector since they might not have traditional income documentation. UPI has become one of the most successful instances of digital public infrastructure (DPI) in India, together with Aadhaar and Jan Dhan; its open, interoperable and inclusive design has changed the way in which citizens carry out transactions, access services and take part in the formal economy. The global recognition of the UPI payment ecosystem is increasing, since UPI is being used in several international markets and acts as an example of a real-time payment system around the world. Experience gained in India shows the way in which digital public infrastructure can promote innovation, financial inclusion and economic growth on a large scale. 

The fact that digital payments are available free of charge has increased involvement among women entrepreneurs, self-employed people and low-income households. Since it enables users to carry out digital transactions without having to pay fees, UPI provides opportunities for financial empowerment and economic inclusion.

The digital payments system in India has achieved its success through keeping costs low and by building trust. The introduction of UPI MDR charges could lead to increased expenses for merchants, particularly for small and informal businesses which operate with very narrow margins. This might cause these businesses to hesitate in accepting digital payments and thus slow down the process of merchants joining the system.

The quick growth of UPI has allowed fintech companies, banks and technology firms to develop value-added services based on payments, such as lending, insurance, wealth management and embedded finance products. Since the UPI merchant discount rate is still zero, the various platforms have been able to concentrate on customer acquisition, innovation and greater financial inclusion.

The transaction records produced through UPI have now become a key factor in the process of granting credit. Nowadays, both banks and fintech lenders use transaction data to evaluate whether potential borrowers are eligible and to assist new customers who have no prior credit history. The fact that the transaction system is kept at zero cost helps to maintain high levels of transaction activity and reinforces the data records that are needed for inclusive lending.

In Tier 3 through Tier 6 cities and in rural areas, the infrastructure for digital payments has expanded considerably, but uptake is still affected by concerns about affordability and trust. It is regarded as essential to keep India's Zero MDR policy if the next phase of digital adoption is to take place among rural consumers, small merchants and other disadvantaged groups.

Conclusion

The UPI Zero MDR policy has always formed a key part of the transformation of India's digital payment system, since by removing the charges on UPI transactions for merchants, it has sped up merchant uptake of UPI, improved UPI's contribution to financial inclusion, widened access to credit, and allowed broad participation in the digital economy. As India carries on its path to becoming a digitally empowered and inclusive economy, it is essential to maintain zero MDR on UPI transactions if growth is to be sustained, innovation is to be encouraged, and the benefits of digital payments in India are to reach every citizen, business and community. 

The future of UPI: Why Zero MDR matters for India

The future of UPI: Why Zero MDR matters for India

 

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