During the last decade, India has made commendable progress in the digital space, particularly in the retail segment of the payment and settlement system, following several initiatives by the RBI and the government. Nevertheless, India’s currency-GDP ratio is one of the highest among major economies.

Despite the cap prescribed by the government, cash transactions are rampant among traders, professionals and businessmen to hide income, avoid payment of tax and accumulate large unaccounted income. Moreover, most anti-social activities, including money laundering, drug financing, and terrorist activities are typically financed by cash. India’s general public prefers cash transactions mainly due to poor digital/financial literacy, inadequate availability of digital infrastructure in rural areas, and high charges imposed on users of digital transactions.

There are mainly two types of digital transactions — person-to-person (P2P) transfers and person-to-merchant (P2M) payments for purchases of goods or services. In India, major P2P funds transfer systems are Real Time Gross Settlement (RTGS), National Electronic Funds Transfer (NEFT) and Immediate Payment Service (IMPS).

The RBI as the owner of RTGS/NEFT does not charge the PSPs, except for membership fees. However, PSPs charge the originator of such payments, which is generally uniform and levied on a per transaction basis irrespective of the amount transferred. Online NEFT is free of charge while IMPS/RTGS charges are nominal.

Fixed and variable costs

While National Payment Corporation of India (NPCI) is a not-for-profit entity, promoted by the RBI and the Indian Banks’ Association for retail payments, other retail PSPs, except public sector banks, are private entities. They incur costs — both fixed and variable — for providing payment services, which need to be recovered from users. They charge the beneficiaries a fixed percentage of the transaction value called Merchant Discount Rate (MDR) subject to the cap stipulated by the RBI and share the amount among the issuer of the instrument, acquirer and network service provider at an agreed proportion.

MDR on credit cards is usually higher than that of debit cards due to the credit risk borne by issuers. NPCI’s Universal Payment Interface (UPI) is a unique instrument, which can be used for both P2P and P2M transactions.

One of the government’s major endeavours in promoting retail transactions has been zero MDR for payments through UPI and RuPay debit cards since January 1, 2020. Budgetary provisions of ₹1,500 crore each were made for FY22 and FY23 to compensate the PSPs facilitating digital transactions free of MDR through these instruments. There was a phenomenal growth of UPI transactions — 46 billion in volume and ₹84 trillion in value — constituting about 64 per cent of total volume of digital transactions in FY22. This has created an imbalance in the level-playing field for other instruments.

The RBI has recently placed a Discussion Paper on Charges in Payment System in the public domain seeking feedback on 40 questions, latest by October 3, 2022. Although charges-related issues are open for discussion, the RBI articulated that “in any economic activity, including payment systems, there does not seem to be any justification for a free service, unless there is an element of public good and dedication of the infrastructure for the welfare of the nation.”

This was perceived as if zero MDR on digital transactions through UPI/RuPay debit cards would be withdrawn. On August 22, the Finance Minister clarified that “there is no consideration in Government to levy any charges for UPI services.” But the issue, of who would bear the expenses relating to digital transactions, remains unresolved.

Both digital products and PSPs are a heterogeneous lot. Free service in respect of a few instruments will create an uneven playing field. Innovations need to be promoted through competition which would ultimately reduce transaction costs. While balancing between level-playing field and innovations, users’ interests cannot be sacrificed. Until digital transactions displace cash transactions in a big way, the RBI has to regulate the charges and keep those well below that of RTGS . Ultimately, all digital transactions are settled in banks.

Due to the spectacular increase in digital transactions, particularly through UPI, the current and savings account balance as a proportion to total deposits of scheduled commercial banks, which was around 42 per cent in FY19, increased to more than 45 per cent in FY22. Most card issuers are banks that enjoy the benefit of low-cost CASA deposits, partly due to large digital transactions. Pressures on ATMs for cash withdrawals have moderated commensurate with the rise in digital transactions. These indirect benefits should be transferred to users.

Digital infrastructure is certainly a public good. The government is seized about this and pursuing policies to promote the digitisation programme in several fields. Even if digital transactions are fully subsidised, cash transactions will thrive due to vested interests that persisted for decades. The central bank digital currency, contemplated by RBI/Government, has a fairly good potential to reduce physical cash transactions going forward.

The writer is currently RBI Chair Professor, Utkal University