By removing MDR, or Merchant Discount Rate, for businesses with annual turnover of more than Rs 50 crore, for UPI and RuPay transactions, the Government of India has effectively destabilised a well established market norm of incentives in digital payments, and will end up creating perverse incentives in the payments ecosystem. Merchant Discount Rate is what merchants pay banks per digital transaction, and in some cases, merchants transfer the cost of MDR to customers.

Some comments on this development:

1. Dangerous play with incentives: Zero MDR is a goal that the government has been chasing for a while now because it needs to bridge the gap between cash and cashless transactions. In case of cash, the cost of cash is borne by the government, and there’s anonymity and tax evasion arising out of that anonymity that the government wants to address. In digital transactions, the anonymity gets addressed (and the government hopes this will address tax evasion too), but the cost of money gets transferred to merchants (and hence customers), through MDR. The government is trying to address the disincentives for digitisation of transactions with Zero MDR, by reducing the cost of transactions for merchants and customers.

However, with Zero MDR, and with the government being unwilling to foot the bill for it, they remove any income from digital transactions for banks, and thus remove any incentive for banks to roll out digital payments infrastructure. The presense-less nature of digital transactions also suggests that fraud detection becomes more tricky (and hence expensive). Thus, with an increase in digital payments, the costs of enabling them and preventing fraud will increase. This thus creates a disincentive to grow digital payments for banks, since it isn’t a source of income with Zero MDR. Naveen Surya, Chairman Emeritus of the Payments Council of India, had said in a statement in July 2019, “Considering Digital Payment in retail is little more than just 10%, we have miles to go and need many more players to be willing to invest and work to provide these services. This announcement of industry bearing MDR would lead to the whole digital payment industry without any business and revenue model.”

It hurts UPI apps and payment service providers too. Loney Antony,Vice-Chairman, Hitachi Payments, had then said, “Non-Bank payment service providers (PSPs) like aggregators/processors are a significant part of the ecosystem. If there is no commercial model, they will be forced to shut down, banks may have multiple ways to recover money from the merchants, but non-bank players do not have any other avenue than the MDR.”

2. Privacy disincentives in Zero MDR: As an alternative, Zero MDR in UPI means that the only remaining incentive for a UPI app to exist is to collect data and sell user data to other financial entities. That’s a perverse market incentive, and perpetuates the current broken business model of internet businesses, which hinges on playing fast and loose with consent, and hence results in privacy violations. At a recent discussion on the draft Personal Data Protection Bill, someone made the point about the impact of purpose limitation on such businesses: that transaction businesses might be unable to share data with credit scoring businesses, or use that data to profile people to offer them additional targeted services.

3. The politics of Mastercard+Visa vs RuPay+UPI: The geopolitics of payments cannot be ignored. With RuPay, the government is trying to create its own infrastructure to compete with Mastercard and Visa. Like China’s UnionPay, The Indian government wants to have its own independent payment network because of the threat of the impact that potential sanctions (especially with a vindictive and irrational US President) could have on India’s payments ecosystem, and hence its economy. The idea here is to create an incentive for RuPay and UPI versus Visa and Mastercard, which in turn means that RuPay and UPI acceptance by merchants is going to be more pervasive going forward.

For Visa and Mastercard, it’s good that they aren’t imposing Zero MDR on all digital transactions: the rails for transactions is their core business and Zero MDR hurts that. However, one has to question the Government of India creating financial incentives for one privately owned company, NPCI, which runs both RuPay and UPI, versus another one. Remember that, in the past, the Government of India has spent taxpayer money promoting NPCI’s BHIM application. Government backing for a competing private application impacted fund-raising for fledgling UPI apps then, which is why UPI itself is now the preserve of highly capitalised companies and start-ups, and competition is largely limited to them.

Do leave a comment if I’ve missed any point, or if you disagree with any point.