"Zero-MDR made UPI a public good but left it under-funded." Examine the case for and against a Merchant Discount Rate on UPI.

Since January 2020, the Merchant Discount Rate (MDR) on BHIM-UPI has been zero under Section 10A of the PSS Act, 2007 and Section 269SU of the Income-tax Act [3]. UPI became nearly free to use, but banks, payment apps and NPCI kept paying to run it. A 0.4% MDR on person-to-merchant (P2M) payments above ₹2,000 begins on 15 October 2026 [1]. It is a reasonable correction, but it needs careful design.

Case for MDR

• Funding gap: RBI's 2022 Discussion Paper showed that payer and payee banks, apps and NPCI each bear costs on every UPI payment [5]. It also said there is no case for a free service unless it is a public good.
• Budget dependence: Yearly schemes, such as the ₹1,500 crore incentive for 2024-25 [4], make spending on fraud control and cybersecurity depend on each year's Budget.
• Narrow targeting: P2P transfers and about 96% of merchant payments stay free [2]. Payers are not charged. A ₹300 cap applies, and merchants receiving up to ₹1 lakh a month are exempt [1].
• Not a tax: The MDR money goes to banks and apps in the payment chain, not to the government [2].

Case against MDR

• Hidden benefits: UPI cuts cash-handling costs, speeds up account reconciliation and gives lenders a record of a trader's cash flow. None of this shows up in UPI's own accounts. If merchants go back to cash or add the fee to prices, the value lost (deadweight loss) could exceed the fee collected.
• Weaker formalisation: A move back to cash would erase the digital records that widen the tax base and help small traders get credit.
• Cliff at ₹2,000: The 2025 scheme paid small merchants a 0.15% incentive on payments up to ₹2,000 [3]. Above that line they now pay 0.4%, which encourages bill-splitting. RBI had suggested tiered charges instead of a single cut-off [5].
• Public-good principle: Charging for UPI weakens its role as digital public infrastructure that anyone can use.

Way forward

• Publish data on payments bunching just below ₹2,000 and on any fall in merchant UPI use.
• Move to graded MDR bands if bill-splitting appears.
• Keep Budget support for small merchants, where the wider benefits are largest.

UPI therefore needs a mixed funding model: merchants who can afford it pay a modest charge, and the Budget continues to support the smallest users. This keeps the system secure without giving up its inclusive, public-good character, in line with SDG 8.10 on access to financial services.