Discuss the significance of zero Merchant Discount Rate (MDR) policy on UPI in advancing financial inclusion in India. What are the fiscal sustainability challenges associated with it?

MDR is the fee a merchant pays its acquiring bank on each digital transaction. Since January 2020, MDR on BHIM-UPI and RuPay debit transactions has been zero, backed by Section 10A of the Payment and Settlement Systems Act, 2007 and Section 269SU of the Income-tax Act, 1961 [1]. Free-at-point-of-use is thus a deliberate policy choice, not a technical feature — and its cost has to sit somewhere.

Significance for financial inclusion

• Removes the entry barrier for micro-merchants: the incentive scheme covers P2M transactions up to ₹2,000 at zero MDR, paying acquirers 0.15% of value [2]. A vendor can accept a ₹20 payment without losing margin — impossible under card MDR.
• Scale achieved: UPI accounts for roughly 49% of global real-time payment volumes [3], and P2P payments remain permanently free for citizens [4].
• Formalisation: every accepted payment builds a verifiable digital footprint, improving small merchants' access to formal credit.
• Legal protection for the payer: Section 269SU bars merchants from passing digital-payment costs to customers [1].

Fiscal sustainability challenges

• Flat corpus against uncapped growth: the scheme is a fixed ₹1,500 crore annual outlay [2], so per-transaction compensation thins mechanically as volumes rise.
• No multi-year certainty: each cycle needs fresh Cabinet approval [2], leaving banks unable to amortise infrastructure investment against it.
• Regulator's own caution: RBI's Discussion Paper on Charges in Payment Systems holds that payment providers must earn income to fund continued operation and technology investment [5].
• Hidden cross-subsidy: lacking a direct revenue line, banks recover costs through minimum-balance, ATM and SMS charges — shifting incidence onto the very low-income users inclusion targets.

A threshold-based, nominal MDR on high-value merchant payments — as enabled by the proposed amendment to Section 10A, leaving ~96% of P2M volume untouched [4] — can reconcile viability with inclusion, provided small tickets stay exempt and counter-surcharging is penalised. Better still, UPI's shortfall should be funded openly as digital public infrastructure, like roads or the grid, rather than renewed annually as a discretionary subsidy.