UPI is free. Someone is paying for it. A short note on the MDR question.

The merchant discount rate on a payment transaction is the small percentage of the transaction value that the merchant pays, through his bank, to the network and the issuing bank, in exchange for the privilege of accepting card or digital payment. On a credit card transaction, it is typically in the range of one and a half to two and a half per cent. On a debit card, somewhat less. On UPI, since the beginning of 2020, it has been zero.

The zero arrived by way of the Finance Act, 2019, which inserted a new Section 269SU into the Income Tax Act, requiring large businesses to offer prescribed digital payment modes — and, in a separate notification, prohibited the levy of MDR on UPI and RuPay debit. The policy was framed as a measure to push digital adoption. It was, more accurately, a price control.

The hidden cost of zero

A price control has consequences. The cost of running a payment rail does not become zero simply because the price has. The settlement infrastructure, the dispute resolution, the fraud monitoring, the inter-bank reconciliations — these are real expenses, paid by the issuing bank, the acquiring bank, the National Payments Corporation of India, and the various technology vendors who keep the rails operating. When the merchant stops paying for these, someone else does.

The government's subsidy scheme for UPI is, in plain English, the price of the price control.

The government has, since 2021, run a budgetary subsidy scheme that compensates banks for the MDR they cannot charge on small-value UPI and RuPay debit transactions. The scheme has paid out a few thousand crore rupees a year, which is not a small number, but is also not a large one in proportion to the volume — over a hundred billion transactions a year — that the rails now carry. The cost per transaction, to the public exchequer, works out to a fraction of a rupee.

The decision that has not yet been made

Whether the arrangement is durable is a separate question. A subsidy that scales with transaction volume is one that gets larger every year for as long as the volume does. The day will come, possibly soon, when the country has to decide whether MDR on large-value UPI transactions ought to return, whether the subsidy ought to grow indefinitely, or whether the rails ought to be funded in some third, undecided way. The decision will not be made by the central bank, by the NPCI, or by the merchants. It will be made by whoever is writing the budget that year.