Zero MDR In UPI: Is Big Tech’s Influence Killing Payments Innovation In India?

“Remember Russia?… With UPI, India was supposed to make its own path, the reality though is starkly different!”

A founder-developer, who worked closely on the UPI project, is deeply pained by how the Indian payments market has evolved.

In 2014, amid fresh sanctions from the US, Visa and Mastercard, which controlled over 90% of the market in Russia, had blocked a series of banks and their customers, creating a major furore in Russia. The two companies together had the power to bring down the entire Russian payments ecosystem.

Today, while some differ, many Indian founders are lamenting that despite having homegrown financial products such as UPI, the Indian fintech market is captured by foreign players.

UPI was supposed to be India’s response to US card systems and its monopoly across the world. However, despite having achieved 2 Bn transactions a month, it’s ultimately the US companies Google and Walmart-owned PhonePe, who together control over 80% of the UPI transactions.

“Zero MDR in UPI has allowed US giants to recapture the Indian payments market which was fast shifting towards Indian startups and companies,” the founder, unwilling to speak on the record on matters related to the government policies, said on the condition of anonymity.

The MDR (merchant discount rate) is the transaction cost paid by merchants to issuers, acquirers and merchant aggregators. In December, 2019, the Indian government had introduced zero MDR for UPI and RuPay which stated that business establishments with an annual turnover of more than INR 50 Cr shall have to compulsorily offer low-cost digital modes of payment to their customers and that zero MDR shall be imposed.

The move came right after the General Elections in 2019, despite the finance ministry’s Watal Committee stating earlier,

“The MDR must be low enough to ensure that merchants adopt the payment method, and encourage customers to use such payment methods. At the same time, the MDR must be high enough to cover costs, and incentivise issuers and acquirers to keep acquiring a greater number of merchants.”

So what happened? How did India allow things to get to a point where zero MDR has become the norm and where transaction caps have to be applied to create a balanced ecosystem?

As the zero MDR policy is about to mark its anniversary, the payments industry observes a plethora of side-effects that have destabilised the Indian payments market. Has zero MDR succeeded in enabling a pro-consumer digital infrastructure?

Speaking to Inc42, Sanjay Swamy, a partner at VC firm Prime Venture Partners, said that India needs to find the right balance.

“I do believe we will need to find a more stable model that works for the industry and the entire value chain — from banks to NPCI to the PSPs to the TPAPs to the merchants and the consumers. Right now we have an unstable ecosystem and unless we find a practical business model that works for everyone, it will be hard to sustain this,” Swamy said.

The Maths Behind UPI Transactions

The cost associated with any digital payment transaction today consists of the cost of the hardware and the facilitation or transaction cost. In the case of UPI, which aimed to be a lightweight payments transaction medium, the hardware was almost zero (except a smartphone).

The transaction cost, which is in the form of MDR, is mainly paid by merchants is distributed among aggregators, acquirers, networks, issuers, technology providers. While a major chunk of the MDR which varies from 0 to 3%, almost 60%-80% goes to the issuers i.e. PSPs or banks who enable the transactions, acquirers and aggregators get the rest.

While the MDR charges were nearly zero for below INR 2,000 UPI transactions since 2017, it was in December 2019, the government introduced zero MDR on UPI and RuPay transactions for businesses above INR 50 Cr of annual turnover.

In its justification, the government asserted that the transaction cost can be compensated against the cost savings by the stakeholders during digital payments. Finance minister Nirmala Sitharaman had then said, “RBI and banks will absorb these costs from the savings that will accrue to them on account of handling less cash as people move to these digital modes of payment.”

However, there is no reference point or study to back this claim, said Deepak Abbot, cofounder of IndiaGold and former VP at Paytm. In contrast, neither the Watal Committee in 2016 nor the Nilekani Committee in 2019, had recommended the zero MDR. In fact, the Nilekani Committee in its report suggested that India should focus on letting the market compete on the merits of the product rather than force adoption.

“The committee recommends that the regulator should adjust the interchange rate and let the market compete on MDR ultimately growing the acceptance ecosystem rather than inhibiting it.” — Finance Ministry’s Nilekani Committee, 2019

Payment apps have been required to make the transition from payments-as-a-fee to payments-for-free with other data or value-added services. Prime Venture’s Swamy said that it’s unclear yet as to whether this is long-term viable but it’s clear that the cost structure should move to a fixed cost/flat-fee model and can no longer be seen as a long-term profit-centre.

Dewang Neralla, CEO of Atom Technologies said that back in 2016, the government and RBI had put an upper limit on debit card transactions based on the assumptions that it was high as 2%-2.5%. However, that was in the case of credit cards and not debit cards. Further, merchant aggregators like Atom Technologies get a very tiny share of the MDR, even from cards.

On the zero MDR concept, Neralla explained, just like building a road infrastructure needs resources and money, building a payments infrastructure cannot happen without revenue or capital. The concept of zero MDR is completely wrong in principle and antithetical to this.

From Indie Innovators To Capitalists

UPI, once a den of India’s leading innovators, has now become a battleground for US giants like Google, Amazon and Walmart, with Facebook joining the fray. These mega-companies have been offering massive discounts and cashbacks since beginning without even bothering to look at the revenue deadlock and negative profit margins.

The foray of these big tech companies has created a lobby of sorts where the payments landscape is dominated by bigger players, with small startups consigned to the sidelines. With zero MDR, Indian startup players that had the early lead in India’s payments innovation have suddenly become the backbenchers looking for honourable ‘exits’ from the segment.

Mahagram, which has been working with over 120K merchants enabling doorstep banking services and other fintech services, is planning to integrate UPI payments too. CEO Ram Shriram is, however, cautious because of the flip-flop in policymaking

“This (UPI) has now been reduced to whoever has the money is buying the consumers. It’s pure capitalism…In the long run, you won’t see multiple players in this space, only a few deep-pocketed players,” Shriram said.

Seconding this, Prime Ventures Partner’s Swamy added smaller players will be wiped out and we are already seeing this happen. Companies that have “other” businesses may subsidise payment processing but a pure-play payments startup has no hope of making money. This is also visible in the ecosystem where no VC has funded any pure-play payments processing companies in the past year and it’s unlikely to happen in the near future, he claimed.

Startups Innovate, Government Disrupts

“Like Aadhaar, they don’t have roadmap again,” Ram Shriram, Mahagram said.

Among the other key electronic payment systems across the world are the US payments card system, mPesa by Kenyan telecom giant Safaricom and the Chinese QR code payments system popularised by WeChat.

While in the case of mPesa, depositing money into the wallet is free, the company collects monthly transaction fees from merchants against its services. The decades-old US card system has reinvented itself massively in recent years and is largely dependent on MDRs which ensure certain profit margins for every stakeholder.

In the case of China, however, the QR code payments by Tencent and Alibaba are ecosystem-driven and have been introduced to strengthen the ecosystem as part of the larger business. While they earn commissions from merchants based on sales volume and contractual clauses, the overall profits of these companies are actually driven by their other businesses such as ecommerce. This has been massively successful with over 700 Mn people expected to do mobile payments in China by 2022.

In all these innovations, one of the key stakeholders — the regulators — have been pro-business and have ensured that the innovators and players do gain from the business in the long run. Visa and Mastercard have even influenced a slew of US laws around payments to ensure the profitability and return over long-term investments that they made.

In India, however, the situation is completely different. There is chaos and confusion among key players including startups, investors as well as regulators over which payment mode other than the cards will offer return on investments.

One of the key factors is not building a long-term policy around payments innovation and infrastructure to ensure the returns on investments. Mahagram’s Shriram said Paytm and many others had heavily invested in wallets which became a popular mode of payments during demonetisation. A number of companies including Zomato, BookmyShow, Makemytrip invested in wallets. However, right after demonetisation, came UPI and suddenly everyone started making investments in UPI and the wallet model died a slow death. Many of the startups that had launched wallets suddenly saw the irrelevance of the model.

The regulators, with zero MDR, have disrupted the business model further to the point that nobody is investing in scaling up the UPI infrastructure. The model itself needed more refinement, maturity in terms of technology and product experience, Shriram said.

“It took decades before US cards became a globally accepted phenomenon. UPI is yet to see maturity as you still have to ask, ‘Bhaiya, Phonepe chalega?’,” Shriram added.

Not All Startups Want Zero MDR Gone

And, it is not only the Indian government but also NPCI which is equally party to this. Even before UPI 2.0, the NPCI came with RuPay mode of payments and suddenly, there was one more tectonic shift in India’s payments space.

And, now that there is RuPay, they have come up with NCMC cards. This constant disruption has to either stop or be seamless, and the regulators must pave the way for technologies to mature, acquire markets with space for having returns on investments made on infrastructure.

However, not every startup or investor is opposed to zero MDR. BharatPe, Paytm and some other homegrown payments startups have been vocal about zero MDR.

Stepping into devil’s advocate shoes, BharatPe’s group president Suhail Sameer said, “We would like to argue that zero MDR has, in turn, switched on the innovation tap in the fintech space. It is today difficult (and rightly so) to make profits on relatively simple products like UPI payment acceptance. We believe over a period of time, the same would get replicated on the card acceptance space. Charging on these products, as I have pointed before, is counter-productive to driving widespread adoption of digital payments. This has forced fintech companies to look at other monetization avenues like commerce, inventory management, or lending. This would unlock the next level of growth in the economy, especially in the SME/ MSME sectors.”

In the past, Paytm chief Vijay Shekhar Sharma has also indicated that zero MDR regime is beneficial for the ecosystem, but it must be noted that given that Paytm has diversified its products beyond UPI, it would be in its interest to have zero MDR in UPI, which is not Paytm’s core focus. However, Sharma also added, “While I am on the side of MDR becoming zero being a good thing for the merchant, the government should reimburse people who are acquiring merchants.”

The Woeful State Of UPI Customer Service

Investors such as Swamy told us that it is unfortunate that companies need to keep investing in improving the product experience for businesses and consumers and over time this would hamper product innovation, quality of service and availability during peak times. At this point, most companies are eating the cost and bravely trying to serve the customer, added Swamy.

Others too referred to the poor after-sales service that UPI payments has become infamous for. The grievance redressal system that the NPCI website shows has largely been on paper. “If you go to Google Pay asking regarding a payment issue, Google Pay would ask you to consult the issuer, the bank who enabled the payments, while the banks would tell you to consult Google Pay. In all this, it is the customer who suffers,” Mahagram’s Shriram said.

And, due to zero MDR, changing norms, no player is willing to invest in after-sales service and product experience.

A PhonePe spokesperson told us, “Merchant acceptance is a very important factor contributing towards the growth of digital payments and MDR plays a critical role in fueling the growth of acceptance across the country.  Without any incentive, the prevailing zero MDR regime impacts investments in building merchant acceptance.”

Banks have lost interest in UPI too, believes IndiaGold’s Abbot.

“You won’t see any bank offering any UPI offers, or even encouraging users to use their UPI apps. They know that Google Pay, PhonePe and others would continue to push UPI and they don’t need to double down on it. As a result, the infrastructure is taking a hit. Look at the downtime that SBI, HDFC have faced on UPI…clearly, they are not prioritising the scaling of UPI,” Abbot said.

Should Government Take On The Cost Behind Zero MDR?

Most of the payments startups agree that zero MDR can not be a permanent model to operate. And, it has not even helped the consumers, as initially promoted by the government.

Swamy clarified that it has nothing to do with consumers — the cost of payments is typically borne by the merchants, i.e. the receiving party. The challenge in India is that with a common pricing product for in-person and online transactions, we are unnecessarily painting the world with the same brush. For physical transactions through UPI, it’s hard to justify MDR, but for remote transactions, all merchants are comfortable with reasonable charges.

“I feel the correct solution will be to differentiate between the two and charge a small fee for face-to-face and a higher fee for remote transactions – because the convenience over cash is much higher and justified in the latter case,” Swamy said.

It’s worth noting that the RBI and the government have extended reimbursements to reduce the MDR burden in the past. The government had in fact stepped in to pay MDR costs for transactions lower than INR 2000. However, the same has not been happening in 2020, said some of the startups. There’s no clarity whether the government is willing to cover the MDR cost or not and if yes, to what extent. It has been estimated that in 2020, the MDR on BHIM UPI and RuPay payments amounts to INR 1,800 Cr which payments stakeholders want the government to pay.

Swamy asserted that the government is definitely a beneficiary and any input credit that can offset the cost of digital payment processing would be a win-win. “I’m hopeful that over a period of time we will move to a more viable approach. There is no need to go to the 2% MDR regime – but covering costs with some margin will enable the providers to ensure product innovation and quality of service,” he said.

Abbot believes that UPI payments can not be a way of revenue generation by itself. Instead, it should be used as a business enabler. For instance, WhatsApp Payments is not here for revenue generation but as an enabler for ecommerce.

Similarly, BharatPe which largely generated consumers from UPI payments is now using lending to make profits and support the UPI growth.

So should India’s UPI payments go to war with cards or take the Chinese route and co-opt merchants? Even as the future seems muddled, the biggest companies tapping the UPI wave have the wherewithal to continue spending large amounts to grab customers and data. If indeed pure-play UPI businesses in India don’t have a revenue future, the zero MDR regime is creating a tilted market.

Can startups really be expected to piggy-back off payments for years on end, even if it takes up big resources and delivers no returns?

With no money in the game, the smaller players will continue to face an entry barrier that does not seem to impact big tech giants. So even as zero MDR is seen as a democratisation move, it is in fact helping solidify the dominance of tech giants in the payments space. Then there’s the biggest question that the government is yet to answer — if the goal is to promote digital payments and financial inclusion, isn’t enabling only the biggest companies creating a bigger divide?