Complex priorities: On UPI transactions, MDR charges

The Merchant Discount Rate (MDR) charges announced for UPI transactions show how political considerations can dilute economic benefits. In a quest to preempt political attacks, the rate structure announced by the National Payments Corporation of India has been made overly complex. From October 15, the new rates will apply only to UPI payments of ₹2,000 or more made at merchants. As such, the charge is limited to only about 2.5% of all UPI transactions, which is a welcome limitation. Yet, within this, the rules have created different gradations. UPI payments made at small merchants earning less than ₹1 lakh a month are exempt. Those made to merchants operating in certain essential sectors will attract a flat MDR charge instead of the 0.4% applicable on other sectors. Capital market payments above ₹2,000 will attract a different MDR. These are clearly designed keeping political backlash in mind. However, they raise some important doubts among merchants, and could potentially slow the adoption of UPI in India. For example, the rules are not clear on what happens to a small merchant who crosses the ₹1 lakh a month turnover threshold, which is a low limit at today’s prices. Who is monitoring their incomes? This will either increase the compliance burden on small merchants, or involve a new mechanism for real-time transaction-checking that banks will have to develop. In the short run, it will likely result in small merchants simply refusing to accept UPI until greater clarity emerges.

The government has also instructed banks to make sure that merchants do not pass on this charge to customers. But it has not specified how banks are expected to check whether merchants tweak their prices to absorb this additional charge. A back-of-the-envelope calculation based on past trends suggests that the MDR will yield an upper limit of ₹2,400 crore of monthly revenue for the payments ecosystem. The sector-wise flat rates and reduced rates will likely result in a lower amount. The government has denied any U.S. pressure to bring these rates to favour American credit card companies. Yet, the data suggest that the benefit will largely accrue to private banks and U.S.-owned UPI apps. There is still an argument to be made for the Reserve Bank of India to foot this bill from the vast surpluses it generates every year. Maintaining vital payment infrastructure is surely a good use of these funds. However, if the government persists in implementing this charge, it should certainly simplify the structure. There is still time before its rollout. The Goods and Services Tax experience shows that rate complexity hits small businesses the hardest.