Payment and Settlement Systems Act, 2007: UPI MDR Framework

Subject: GS 3: Economy

Context: The government has proposed amending Section 10A of the Payment and Settlement Systems Act, 2007, to allow a Merchant Discount Rate (MDR) of 0.25–0.5% on UPI transactions above ₹2,000.

• Introduced via the Taxation and Other Laws (Amendment) Bill, 2026.
• Amends Section 10A of the Payment and Settlement Systems Act, 2007, giving the government legal power to notify charges on specified electronic payment modes.

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• Transaction Impact: The threshold is expected to cover around 5% of UPI transactions by volume, but these account for approximately 65% of transaction value.

Why was UPI’s Zero-MDR Policy Adopted?

• Promoting Digital Payments: Zero MDR reduced the cost of accepting digital payments and encouraged merchants and consumers to shift from cash to electronic payments.
• Financial Inclusion: UPI enabled small merchants and low-income users to participate in the formal digital financial ecosystem without significant transaction costs.
• Formalisation of the Economy: Digital transactions create a traceable financial trail, supporting financial transparency, tax compliance and formalisation.
• Digital Credit: Digital transaction histories can help assess cash flows and creditworthiness, particularly for small businesses lacking conventional financial records.

Who Ultimately Bears the Cost of MDR?

• Two-Sided Market: UPI operates as a two-sided market, connecting consumers and merchants through banks, payment service providers and fintech companies.
• Merchant: MDR is formally imposed on the merchant side of the payment ecosystem.
• Consumers: Merchants may pass part of the additional cost to consumers through higher prices or transaction charges, depending on market conditions.
• Banks and Fintechs: If merchants cannot absorb or pass on the cost, banks, payment service providers and fintech companies may bear it through reduced margins.
• Innovation Risk: Lower margins could weaken investment in payment infrastructure, cybersecurity, fraud prevention and innovation.

Why is the Proposal a Concern?

• Policy Reversal: The proposal represents a potential reversal of the zero-MDR policy that helped establish UPI as a mass-market payment platform.
• Risk to Adoption: Even a modest charge could influence choices between UPI, cash, cards and other payment instruments, particularly for businesses with thin margins.
• Threat to Financial Inclusion: Higher transaction costs could discourage some merchants and users from shifting from cash to digital payments.
• Formalisation Concerns: Reduced UPI usage could slow the growth of traceable digital transactions, affecting economic formalisation and tax compliance.
• Investment Disincentive: Lower returns could reduce incentives to invest in innovation, reliability, fraud prevention and underserved markets.
• Policy Credibility: Frequent changes in digital-payment incentives could create policy uncertainty for banks, fintech companies and merchants.
• Policy Inconsistency: India already imposes 18% GST on credit card interest and fees — unusual internationally, since most countries treat consumer credit interest as a private cost, not a taxable service.

Way Forward

• Evidence-Based Pricing: Any change in MDR should be preceded by an assessment of its impact on merchant behaviour, consumer adoption, fintech investment and financial inclusion.
• Protect Small Merchants: The policy should protect small businesses and low-value transactions from disincentives.
• Maintain Ecosystem Incentives: The system should preserve incentives for banks, fintech companies and payment service providers to invest in reliability, cybersecurity and innovation.
• Ensure Policy Stability: A predictable payments policy framework is essential for long-term investment and ecosystem confidence.
• Explore Alternative Revenue Sources: The government could explore alternative revenue mechanisms that do not undermine UPI adoption and its network effects.

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Conclusion

UPI has evolved into a critical pillar of India’s financial inclusion, formalisation and Digital Public Infrastructure. Any MDR must balance revenue needs with affordability, innovation, adoption and ecosystem sustainability, ensuring that a decade of policy support is not undermined by a sudden policy reversal.

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