While physical infrastructure in India can often be plagued by inefficiencies, the country has made phenomenal progress in creating a digital infrastructure that has put it at the forefront of the digital payments arena. India accounts for nearly 40% of global real-time digital payments, according to estimates from the Indian government.
Speaking at the World Economic Forum in Davos in January this year, the country’s minister for railways, communications, electronics and information technology, Ashwini Vaishnaw said that India’s digital payment transaction value was more than the combined digital payments of the US, UK, Germany and France.
Data from the Reserve Bank of India (RBI), the country’s central bank, shows that between financial year 2020/21 (FY20–21) and FY22–23, digital transactions across various retail and wholesale payment channels grew by more than 2.5 times by volume to 113.9 billion and are worth more than Rs2000tn ($24.14tn).
In a 2022 report on the Indian payments industry, global consulting firm Boston Consulting Group (BCG) stated that digital accounts for 40% of total payments in India, by value — the rest being cash. BCG predicts that the proportion of digital payments will grow to 65% by 2026.
India’s remarkable transformation from a predominantly cash-based economy to a digital payments leader in less than a decade is a case study in government and regulatory policies working in tandem with industry-led technological innovations. A crucial initiative towards this transformation was the RBI establishing the National Payments Corporation of India (NPCI) in 2008 to streamline existing and new retail payment systems in the country.
Low-cost payment rails — combined with rapidly growing smartphone penetration, cheap internet access, a regulatory push towards financial inclusion, a universal digital identification programme, and fintech-led user-friendly innovative digital products — have created some of the key building blocks that have helped create a vibrant digital payments ecosystem.
UPI effect
The main contributor to the rapid growth of digital payments is the Unified Payments Interface (UPI), a payment system that enables instant transfer of funds between two bank accounts using a mobile device. It was launched by the NPCI in 2016, a few months before the controversial overnight withdrawal of large-denomination bank notes. Although the initial response was lacklustre, it gained traction a few years later, during the Covid-19 pandemic when those reluctant to physically handle cash turned to the digital convenience offered by UPI. There has been no looking back.
While cash is king, it is not as powerful as it was a few years back
Between FY20–21 and FY22–23, UPI transaction volume grew by 275% to 83.7 billion. In comparison, during this period, credit card payments grew by 65.2% while debit card transaction volumes fell by 14.9%. UPI today accounts for nearly three-quarters of digital payment volumes. Around 450 banks are part of the UPI network today, as against 29 at its launch. In a recent report on the Indian payments sector, consulting firm PricewaterhouseCoopers (PwC), predicted that UPI will achieve one billion transactions per day by FY2026–27.
By offering customers the convenience of being able to send and receive even very small payments securely and removing the burden of carrying cash or searching for small change, UPI has become the preferred payment mode for low-value transactions. Small businesses and street vendors are increasingly seen displaying QR codes that enable customers to use their smartphones to scan and make payments via the UPI platform.
While earlier UPI was predominantly used to transfer funds between individuals, merchant payments are growing. Peer-to-merchant UPI transaction volumes surpassed peer-to-peer in August 2022. As per RBI data, there was an increase of more than 500% in the acceptance of digital payments by merchants for the period April 2021 to September 2021 compared to the period October 2018 to March 2019. In the same period, RBI says, UPI payments increased by more than 1200%.
It is important to note that UPI transactions currently do not attract any merchant discount rate (MDR) — a fee that a merchant is charged by their issuing bank for accepting payments from their customers via digital means. Unlike cards, where merchants need to typically pay 2–3% of the payment value, UPI transactions have had nil charges since January 1, 2020, as mandated by the Indian government.
In August 2022, the banking industry regulator had issued a discussion paper requesting public consultation on levying MDR on a variety of payment instruments, including UPI. However, within a week, the Finance Ministry issued a clarification stating that fee-exemption for UPI transactions would continue since UPI was a “digital public good with immense convenience for the public and productivity gains for the economy”.
The absence of charge is a key factor towards high levels of merchant adoption, but this is an unsustainable model, says Mihir Gandhi, partner and leader in payments transformation at PwC India. Now that both customers and merchants are past the learning curve, merchants should start bearing some costs, Mr Gandhi says. “There is no such thing as a free lunch. The cost of servicing customers as well as the infrastructure and technology costs are being borne by banks and fintechs. Charges should come in at some point for making it viable from an industry ecosystem perspective.”
An interesting dichotomy in the Indian payments market is that, along with digital payments, cash usage is also growing. Since cash and digital modes are generally expected to substitute each other, the simultaneous rise in both, also referred to as the ‘currency demand paradox’, appears counterintuitive.
Sometimes it takes longer for a country to plan for a platform, like UPI, that can be a game-changer
RBI data shows that between FY16–17 and FY2–21, while UPI-led retail digital payments grew at a compounded annual growth rate of 50% and 27% in terms of volume and value, the currency in circulation (CIC) to gross domestic product (GDP) ratio also rose and peaked at 14.4% in FY20–21. The RBI attributed this sudden uptick in CIC to customers adopting a precautionary approach during Covid-19.
However, the currency paradox was observed after the pandemic too. Comparing the ratio of cash to GDP with the ratio of digital payments to GDP, Sanjeev Moghe, president and head of cards and payments at Axis Bank, observes that the cash to GDP ratio is declining, the latter is increasing. “My sense is that, on the margins as digital payments grow, [digital payments are] replacing the need for incremental cash,” Mr Moghe says. “While cash is king, it is not as powerful as it was a few years back.”
International outlook
UPI has revolutionised digital payments in India. As it continues its growth story, the regulator, along with the NPCI, is now trying to expand its reach and increase the user base. They have launched new products to enable users to make payments with feature phones that do not have smartphone capabilities and even in offline mode without internet connectivity. On the other hand, they are taking UPI global through NPCI International Payments Limited (NIPL).
Ritesh Shukla, CEO of NIPL, says that the company is working on two fronts. First is to collaborate with other countries, to enable them to create their own sovereign digital payments infrastructure for their domestic payments need. Here, he says, a lot of patience is required since multiple dialogues need to be held with multiple stakeholders. “Sometimes it takes longer for a country to plan for a platform, like UPI, that can be a game-changer,” says Mr Shukla.
NIPL’s second target is building interoperability and connecting India with other countries for personal as well as merchant payments. “These linkages will help bolster travel and remittance flows between the countries,” explains Mr Shukla. The Indian diaspora is among the largest globally and India receives among the highest levels of remittances globally. “We are looking at those corridors where Indians travel or reside,” he says.
On this front, Mr Shukla states that NIPL is receiving good traction, the linkages are already live for merchant payments with UAE, Singapore and Bhutan, while conversations are ongoing with other countries. Recently, France joined the list of countries that NIPL is in close discussions with when the Indian prime minister Narendra Modi announced an agreement between the two countries for cross-border merchant transactions using UPI.
While the interlinkage of UPI with other payments systems is very promising, it is a mammoth task, points out Mr Gandhi of PwC. “The partnerships are still at a very nascent stage and the technology still needs to prove itself globally,” he says. “Nonetheless, there is no doubt that there are tremendous benefits of overcoming these challenges. Not only would it establish UPI as a global payment solution, but also help foster innovation in the global payments landscape.”
