UPI MDR: 0.4% charge raises questions over MSME margins, cash flows and digital credit

The new merchant discount rate (MDR) on select UPI (Unified Payments Interface) transactions is set to change the economics of digital payments for merchants starting October 15. Industry representatives argue that a uniform 0.4% charge may not work equally well across businesses with varying margins and turnover.

India is home to around 63 million micro, small, and medium enterprises (MSMEs), many of which are increasingly using digital payments, such as UPI, for day-to-day business transactions.

Notably, under the new framework, a 0.4% MDR will apply to eligible person-to-merchant (P2M) UPI transactions above Rs 2,000. The charge will be paid by merchants. Transactions up to Rs 2,000 will continue to be outside the MDR framework, while qualifying small merchants receiving up to Rs 1 lakh a month through UPI QR will also remain exempt. But for merchants, the will depend on the extent to which they get business from higher-value UPI transactions, their margins, and their ability to absorb the cost.


0.4% can be significant for thin-margin businesses

For high-volume, low-margin businesses, the MDR could be a major blow to profitability if merchants are left footing the entire bill. Ram Iyer, Founder and CEO of supply chain financing platform Vayana, says businesses such as kirana retail, quick-commerce, and FMCG distribution typically operate on net margins of around 3%-5%. He estimated that absorbing a 0.4% MDR could, therefore, translate into an 8%-13% reduction in their net profitability.

The impact, however, will not be uniform across MSMEs. “While 0.4% appears modest on an individual transaction, it can become a meaningful operating cost for businesses processing a high volume of larger-value digital payments,” says Pallavi Shrivastava, Co-Founder of MSME-focused fintech Progcap.

Ranadurjay Talukdar, Partner, Business Consulting and Payments Leader, EY India, says the impact is unlikely to be material for most MSMEs, as more than 95% of UPI merchant transactions by volume remain below the Rs 2,000 threshold and continue to be free. However, Talukdar says that MSMEs operating on thin margins with a high share of larger-ticket UPI payments could see a modest working-capital impact from the additional payment acceptance cost, like large kirana stores, consumer durables outlets, etc. For some businesses, he says, this could incrementally increase demand for short-term financing, invoice discounting, and cash-flow management solutions.

PHDCCI seeks different treatment for MSMEs

The PHD Chamber of Commerce and Industry has argued that the solution should not be a uniform MDR across small, micro, medium, and large businesses. H.P. Kumar, Advisor to the MSME Committee at PHDCCI and former chairman and managing director of the National Small Industries Corporation (NSIC), says the current 0.4% rate should be applied with greater differentiation based on the size and nature of the business.

Kumar suggests exempting micro and small businesses with annual turnover of around Rs 2 crore from transaction-level MDR. He says this should be the first preference, but if a complete exemption is not feasible, policymakers could consider a fixed annual charge of around Rs 5,000 for smaller merchants instead of charging a percentage on every transaction. “The UPI system has infrastructure, manpower, and technology costs, so some mechanism to recover those costs is necessary,” Kumar says, while arguing that the burden should not fall uniformly on small traders.

Kumar also calls for sector-specific treatment as a solution. He says essential consumption categories such as groceries, food, vegetables, fruits, pulses, and spices should be considered for exemption, while higher-value discretionary categories could bear MDR. His argument is based on the difference in margins and the nature of goods consumption. He believes that the case of differentiated rates was particularly strong in sectors with thin margins. He adds that wholesale businesses operate on margins of around 1-2%, making a 0.4% transaction charge substantial relative to their earnings. A uniform rate, he says, does not adequately account for such differences.

Fintech firm Vayana has also proposed sector-specific MDR caps, with lower rates for essential goods and high-frequency, low-margin businesses.

Who ultimately bears the cost?

Another question is whether merchants will absorb the MDR or try to recover it through prices. Progcap’s Shrivastava says the immediate response among many MSMEs could be absorption within margins, changes to discounts or pricing adjustments rather than a direct charge to customers.

PHDCCI’s Kumar, however, believes that the additional cost is likely to be passed on, eventually. “Ultimately, the shopkeeper or trader will pass it on,” Kumar says, arguing that the focus should therefore be on limiting the burden on consumers and small traders.

This creates a key uncertainty around the new framework. While MDR is formally a merchant-side cost, its economic incidence could vary depending on competition, margins, and pricing power in different sectors. The impact on working capital is another area where views differ. Both Iyer (Vayana) and Shrivastava (Progcap) expect MDR deductions to put pressure on cash flows for some merchants.

Shrivastava says merchants with significant digital collections above Rs 2,000 could see a recurring deduction from settlement proceeds, leaving less cash for inventory purchases, supplier payments, and other working-capital requirements.

Iyer expects this could increase demand for short-term working-capital loans and daily-repayment credit lines. Here, Kumar takes a different view. He says working capital should not be the primary concern because merchants are likely to pass the additional cost on to consumers. The more important issue, in his view, is ensuring relief for small traders and consumers.

The differing views underline that the eventual impact will depend on merchants’ ability to pass on the cost. The new thresholds could also influence how some merchants structure their collections. Pallavi says businesses operating around the Rs 2,000 transaction threshold may reassess their preferred payment modes. Industry’s view is that there could also be experimentation around how transactions are structured. Both Pallavi and Iyer flag the possibility that businesses could use more cash or multiple payment channels to reduce MDR exposure. That could result in a less complete digital transaction trail. This matters because fintech lenders increasingly use transaction data to assess MSME cash flows and operating cycles.

“If businesses begin deliberately shifting collections across cash, multiple payment channels or other mechanisms to remain within the threshold, it could have a broader consequence: less complete digital visibility into their business cash flows,” Pallavi says.

Industry experts believe that the new revenue model could also change how fintechs serve merchants.

Pallavi expects payment providers to increasingly bundle payments with reconciliation, cash-flow analytics, inventory management, and working-capital finance.

What industry wants

The industry proposals point to several possible ways of refining the framework.

PHDCCI’s Kumar has suggested a higher turnover-based exemption and a fixed annual fee for small merchants, while Iyer proposed a rolling annual threshold instead of the current monthly limit and sector-specific MDR caps.

Progcap’s Pallavi, meanwhile, has called for a periodic review of the Rs 2,000 transaction threshold and Rs 1 lakh monthly small-merchant threshold as payment behaviour evolves. It has also argued that the proposed fund linked to MDR collections should be used transparently to support digital adoption among smaller merchants.

Lakshmi Venkataraman Venkatesan, founding and managing trustee of entrepreneurship-focused Bharatiya Yuva Shakti Trust, says the Rs 1 lakh monthly exemption is important for small merchants but could become restrictive as micro businesses grow. She adds that affordable digital payments remain important because transaction records can help entrepreneurs build formal financial histories and access finance.