UPI's growth story: ₹1,500 crore push to boost digital payments, but will MDR return?

Driven by the country’s technological prowess, digitisation efforts, a supportive regulatory regime, and the launch of the Unified Payments Interface (UPI) in 2016, India’s digital payment ecosystem has grown exponentially.

To promote this payment ecosystem, PM Narendra Modi-led Centre has approved a ₹1,500 crore incentive scheme for FY25 for low-value BHIM-UPI (P2M) transactions and boost digital payments among small merchants. Launched on March 19, the initiative aims to keep the UPI ecosystem affordable and accessible for all users.

As per the PIB press release, "From April 1, 2024, to March 31, 2025, the scheme offers a 0.15% incentive on UPI payments below ₹2,000 to small merchants, with zero Merchant Discount Rate (MDR). The incentive is paid to acquiring banks and shared with issuers, PSPs, and app providers, offsetting costs as MDR isn’t applicable to RuPay Debit Card and BHIM-UPI transactions since 2020."

UPI enables businesses to accept digital payments without costly hardware or point-of-sale systems, enhancing customer experience and driving cashless adoption at the grassroots level. One can typically scan a QR code and transfer money.

In January 2024 alone, India recorded over 17 billion UPI transactions, reflecting the rapid growth of its digital payment ecosystem. Notably, nearly 50% of these transactions involved small-value payments below ₹200, highlighting the crucial role of low-ticket digital payments in driving financial inclusion and everyday digital transactions.

To ease microtransactions and reduce banking infrastructure strain, the Reserve Bank of India (RBI) launched UPI Lite in September 2022. UPI’s share in India’s digital payments surged from 34% in 2019 to 83% in 2024, while other methods like NEFT, RTGS, IMPS, and cards declined from 66% to 17%.

Merchant payments now make up approximately 62% of all UPI transactions, up from 40% in January 2022. This growth highlights a significant shift in UPI usage from person-to-person transfers to merchant transactions, reflecting increasing adoption among businesses.

In early 2020, the government waived the Merchant Discount Rate (MDR) on UPI transactions amid rising digital payments during the pandemic. While this boosted UPI adoption, it also eliminated a key revenue source for banks, fintech firms, and payment service providers till now. However, as government subsidies shrink, industry players advocate for MDR’s reintroduction for larger merchants. This is because MDR helps cover costs like technology, infrastructure, and data centers, ensuring the seamless processing of billions of transactions each month.

Kunal Varma, CEO and Co-Founder at Freo, a Bangalore-based Fintech firm, said that there is no doubt that UPI has been a game-changer for financial inclusion in India. Its zero-cost structure for both consumers and small merchants has been one of the biggest reasons for its mass adoption, especially in semi-urban and rural areas. "Reintroducing MDR — which is a small fee paid by merchants to banks or payment providers on every digital transaction — could risk slowing down this momentum,” Varma said.

Today, India’s fintech sector is growing rapidly, driven by evolving financial ecosystems. Therefore, reintroducing MDR for large merchants could restore revenue for banks and payment firms but may also raise business costs, potentially disrupting the seamless adoption of digital payments across industries.

"For many small businesses, even a small charge can feel like a burden, and they may either stop accepting UPI or pass the cost on to consumers. That said, the UPI infrastructure does need a sustainable revenue model to support continued innovation and security. A possible middle ground could be tiered MDR slabs or selective reintroduction based on business size, so the growth of digital payments doesn’t come at the cost of inclusion," added Varma.

Effect on payment ecosystem

For everyday users, especially those using UPI for small-ticket spending — like buying groceries, paying an auto fare, or settling a chai tapri bill — the charm of UPI has been its simplicity and zero-cost nature. If MDR gets reintroduced and ends up being passed on to consumers, even indirectly, it could impact consumer sentiment and lead to a shift back to cash, especially for smaller transactions.

Amit Chandel, Co-founder and CTO at Olyv (originally known as SmartCoin), a Bangalore-based Fintech firm, said, “The reintroduction of MDR can have dual effects on consumers and traders. On the one hand, charging for UPI transactions, particularly low-value transactions can deter users who have adopted digital payments due to their convenience and low cost. Small traders, in turn, could switch back to cash if they are burdened with extra expenses, reversing India's digital payments push. Conversely, if MDR is restricted to high-value transactions, the effect on regular users may be negligible.”

However, Madan Sabnavis, Chief Economist of Bank of Baroda, said that it will have to be seen as how consumers behave because if MDR is levied on UPI transactions, the merchants will have to take a call on whether to pass on the cost to the customer. If they do pass on the cost, then the customer reaction comes in. “It has been seen that some merchant sites, as well as service providers, do charge 2% on the use of credit cards though it is zero on debit cards. Here, customers shift from credit to debit cards. Hence if UPI transactions are chargeable individuals will take a call on the same. Intuitively it looks like that large merchants will not pass on the cost but absorb the same to ensure that business is not affected,” he said.

“It is also hard to conjecture right now because once it becomes a habit people may not mind paying the cost. For example, the convenience cost levied by theatres, airline tickets etc., has been accepted by the public because it makes things easy, or they are not aware of the cost. Either way, the business has not been affected. Hence, this may not be a pushback for the digitisation push. However, if some modes like cards are free of transaction cost, but not UPI, the discerning will shift to the alternatives," added Sabnavis.

Conclusion

The government's new ₹1,500 crore incentive scheme for low-value UPI transactions indicates a desire to keep small-ticket digital payments affordable. But if MDR is imposed across the board, it may upset the ecosystem, making digital payments less desirable than cash. The challenge is that any reintroduction of MDR should not reverse the gains in financial inclusion and digital adoption.

"India’s digital payment journey has come a long way, and we shouldn’t risk losing that trust and ease that users have gotten used to. Any move around MDR should be handled carefully, with safeguards to protect the experience for end-users and small merchants, while also ensuring the ecosystem remains financially viable in the long run," says Varma.

UPI has played an important role in advancing financial inclusion, enhancing digital literacy, and shaping India into a digitally empowered nation. By maximising its benefits and potential, the country is set to achieve greater financial empowerment and sustained economic growth in the future.

Chandel said, "If MDR is reintroduced, even in part, small businesses and low-income users who use low-value UPI transactions extensively may incur extra costs, which may deter adoption. However, a balanced approach where MDR applies only to high-value transactions while keeping small merchant transactions free could sustain financial inclusion while ensuring banks and payment service providers (PSPs) recover operational costs. The key is to avoid burdening small merchants and consumers who have been critical to UPI’s mass adoption."

Also, for any emerging sector to thrive, incentives are essential, and digital payments have proven their transformative impact on businesses and lives. Therefore, the key priority now is to sustain this growth momentum without being derailed by speculation driven by vested interests.