"Well, until it's actually brought back, I don’t believe in anything. For years, they’ve been giving hope of bringing it back.”

This weary remark from a top payments industry executive about the MDR (merchant discount rate) on UPI (Unified Payments Interface) perfectly captures the sector’s frustration.

Last week, the government announced a Rs 1,500 crore incentive for UPI and Rupay debit card transactions—significantly lower than the incentives first introduced in the 2019. But this steady decline in subsidies is being read by the industry as a sign: the government may finally be warming up to the idea of reinstating MDR, a long-standing demand.

Let’s be honest—the MDR must return because the illusion of 'zero MDR' on UPI transactions cannot continue.

Beneath UPI’s seemingly frictionless surface lies a complex ecosystem riddled with hidden costs, uneven incentives, and rising tensions among payment players. The industry sees it. The industry knows it. The question is—will the government act on it?

First thing first – is UPI free?

The government’s stance is clear—UPI transactions must remain free. A senior official from a top payment aggregator emphasized that the Finance Minister is adamant: under no circumstances can any charges be levied on UPI transactions, in any form or fashion.

But reality paints a different picture.

Despite the official stance, several payment aggregators—including Razorpay, Cashfree, PayU, and Eazebuzz—have been charging merchants UPI transaction fees under various labels: ‘experience charges’, ‘technical fees’, ‘platform fees’.

The burden falls hardest on small merchants, who lack the bargaining power to negotiate better terms. Meanwhile, large merchants—better informed about regulations—secure favourable deals, effectively making UPI "free" only for them.

"In 2019, it was crystal clear under Section 269SU of the Income Tax Act: UPI transactions cannot be charged, directly or indirectly. Yet, the practice continues," said a co-founder of a leading payment aggregator. "Small merchants don’t have the knowledge or voice to complain. PAs charge them as part of a bundled offering, making it difficult to pinpoint what’s actually happening. Some large PAs have even raised concerns with regulators about this disparity, but no action has been taken.”

[A new provision, namely Section 10A was inserted in the Payment and Settlement Systems Act, 2007 with effect from 1 November 2019. The Section mentions that no bank or payment system provider shall impose any charge upon anyone, either directly or indirectly, for using the electronic modes of payment prescribed under section 269SU of the Income Tax Act, 1961.]

Aggregators that impose ‘platform fees’ argue that they only apply when merchants opt for services like transaction reports and dashboard access. “If a merchant wants to opt out of these services, then UPI transactions remain free,” a senior executive from one such PA told The Head and Tale. “If we were doing anything wrong, the regulator would have flagged it during audits.”

Whether small merchants are even made aware of these opt-outs is another matter altogether. Many PAs offer flat pricing across payment modes—often with an asterisk.

So, is UPI free? The short and long answer is: No.

This loophole – according to the senior official from a payment aggregator firm – is precisely what would have driven PhonePe—the country’s largest third-party UPI app (handling close to 48% of UPI transaction volume)—to enter the payments aggregator (PA) space in 2023.

"In 2021, PhonePe briefly tried charging Rs 1 per UPI transaction for some users but backed down after a major backlash," said the official added. "Market estimates suggest that some PAs are raking in Rs 400-600 crore annually by charging UPI fees. PhonePe has understood that as a TPAP, they cannot charge UPI transactions, but you can get away with charging UPI if you are operating in a small and mid-level merchant PA space.” 

While PhonePe may be eyeing UPI revenues, it initially offered its payment gateway services for free to attract merchants—an aggressive strategy that has clearly rattled its competitors.

Capping MDR incentive on UPI – a brewing battle?

You read that right—the incentive mechanism itself has become a battleground.

Rumors suggest there have been industry discussions to cap MDR incentives on UPI. Currently, these incentives are largely divided between banks and the two dominant third-party app providers (TPAPs)—PhonePe and Google Pay—which together account for nearly 85% of UPI transaction volumes.

Other TPAPs and payment aggregators (PAs), however, receive no share of these incentives. Two leading PA executives confirmed that discussions have taken place where some PAs are lobbying to cap the incentives given to top TPAPs and redistribute them to smaller players in a bid to foster a more balanced ecosystem.

But not everyone agrees. Two senior payments executives strongly denied any such discussions.

Interestingly, there is no official NPCI (National Payments Corporation of India) circular that defines how incentives should be shared between acquiring banks and PAs—leaving PAs with nothing.

One of the top payments industry executives provided critical insights into the incentive breakdown: Of the total MDR incentive, roughly 40% goes to the issuer bank, another 40% to the acquirer bank, 10% to the TPAP, and 10% to the Payment Service Provider (PSP) bank. For a giant like PhonePe, the actual share might be considerably smaller—potentially less than 15% of the total incentive.

Beyond the debate over capping incentives, the real issue remains investment in UPI.

Nobody is investing in UPI anymore—except for a few new players like Navi and Supermoney (by Flipkart)," the payments executive pointed out. Even if Rs 100 crore from PhonePe’s Rs 300 crore MDR incentive were redistributed to new players, it wouldn’t fix the deeper problem.

"The MDR incentive itself holds no real value," the executive argued. "Look at the credit card market—Rs 24 lakh crore in annual transactions with an average 1.5% MDR makes it a Rs 30,000 crore market. By comparison, what the government is offering as an incentive is peanuts," the executive said.

For UPI’s ecosystem to thrive, it would need at least Rs 10,000-15,000 crore annually. Right now, UPI’s growth is slowing. With nearly 1 billion Indians still outside the UPI ecosystem, someone needs to invest in expansion. But without MDR, no one will.

Meanwhile, PhonePe and Google Pay seem to be shifting focus. "They’ve started aggressively pushing tokenization, moving transactions towards credit cards instead. And credit card transactions are growing."

The UPI conundrum – a system under strain

The zero-MDR policy on UPI has triggered a multi-layered crisis—lost revenue, uneven incentive distribution, intensifying competition, and market share concentration. NPCI’s repeated attempts to cap market dominance have largely failed.

"No matter how much we take pride in UPI, the global perception today is that American MNCs—Walmart and Google—control its infrastructure," a senior payments executive noted. Walmart-owned Flipkart is now aggressively pushing UPI acquiring through Supermoney after PhonePe spun out of its ecosystem. For them, this might just be a valuation game.” Supermoney has already broken into the top five UPI processors by volume.

With payments aggregation becoming hyper-competitive, the industry has been lobbying the government to allow charging medium and large enterprises for UPI transactions.

"The Finance Minister argues that the government provides incentives—but let’s not forget, this is taxpayer money," the executive pointed out. "Around 70–80% of UPI transactions come from large merchants like Flipkart, Amazon, and major retail chains. So, in reality, taxpayer money is subsidizing Amazon’s transactions. How is that fair?"

Some industry insiders believe that banks are also to blame.

"Banks don’t push the government hard enough to reinstate MDR. For instance, the State Bank of India likely spends nothing less than Rs 500-600 crore annually just to manage UPI infrastructure," another executive explained.

UPI handles nearly 600 million transactions daily—but there’s an equal volume of balance inquiries, bringing total daily consumer-initiated transactions to 1.2 billion.

Meanwhile, UPI has effectively cannibalized every other direct debit mechanism linked to bank accounts.

For large merchants, the industry has long demanded a controlled MDR of at least 0.25-0.30 bps—enough to sustain the ecosystem. “If at all, give incentives for small merchants,” the payment aggregator executive shared.

But today, it’s clear: UPI is not free for small merchants.

So, does the government intend for large merchants to keep benefiting under the facade of "MDR incentives"? Only policymakers can answer that.

For now, UPI remains a reflection of India’s digital transformation paradox—where some charge, some don’t; some receive incentives, others are left out; large merchants gain, small merchants pay.

The impact? UPI’s growth is slowing.

This chaos won’t end until MDR is officially reinstated.