The announcement of MDR charges for certain UPI transactions from 15th October has created a fair amount of panic and controversy, as one might expect.

One side of the debate is arguing that this is “only for merchants, not consumers”, that the system cannot run for free forever, and that most UPI transactions will remain unaffected. On the other side, ordinary citizens and merchants are understandably concerned. UPI was deliberately built around a zero-MDR model and was subsequently supported by government incentives. So the shift towards a transaction-funded model naturally raises the question: why now, and who exactly is going to benefit from it?

UPI was designed to make digital payments almost invisible: instant, ubiquitous and free. The difficult question was always who pays for the machinery underneath it. The decision presents an interesting economic dilemma. On one hand, there is some precedence for ‘upkeep charges’ here. I tried to research many digital payment systems across the world including credit and debit cards, Brazil’s Pix (similar to India’s UPI), wallet systems like PayPal and Webmoney, etc. and couldn’t find a major payment ecosystem that’s fully free or govt subsidized.

But on the other hand, the govt wastes thousands of crores in useless things like election freebies, care funds, etc. Subsidizing Rs. 2K crores for a UPI system that forms the payment backbone of the country should be a pittance comparatively. Apart from arbitrary thresholds proposed in this framework (like who decided on Rs. 2000 as limit for MDR?), I wanted to understand where this demand is coming from and who in the UPI ecosystem is facing losses that now need to be covered.

The podcast The new UPI equation by The Ken is highly informative in this regard and recommended watch if you’re interested in this topic.

https://www.youtube.com/watch?v=KX5dEhO09xA

The question isn’t really whether UPI costs money. It obviously does. The interesting question is who should pay for it, and who should capture the resulting revenue.

The UPI infrastructure cost is presently borne by both Banks and UPI app developers like GPay and Phonepe. The UPI apps apparently operate on a ‘break even’ model, they don’t earn any revenue from the payment transfers itself but by providing other value added services through their apps like credit and insurance products, travel booking, etc. In the early days of UPI, this model was probably sustainable but overtime it has saturated a lot, perhaps due to too much competetion and UPI coverage approaching its growth limit in the country.

The demand for MDR appears to have come primarily from these app developers as they’re the ones losing the most in this payment cycle. Another interesting aspect is the subsidy received from govt. As mentioned by one of the podcast hosts, the banks take away most of that Rs. 2k crore subsidy received (about ~80%) and very little is left for these app developers. The app developers aren’t happy about it considering they do most of the front facing work like UX development, and banks themselves benefit the most from a cashless ecosystem.

The podcast also talks about how a lot of new players who didn’t enter payment app space earlier may now want to enter. Apps like Zomato and Swiggy will want to become UPI payment providers themselves as it will help them recover the MDR incurred on the transactions. On the other hand, will some merchants and customers go back to hard cash again? In any case, there could be several ripple effects and unknown variables to this move which will come out only on 15th October - if this MDR framework gets implemented.

Some Thoughts on the Economics of UPI and MDR