Union Budget 2022–23: Impact on digital payments with a focus on the digital rupee

Highlights of previous budget (2021–22) related to digital payments

The Government of India has played a pivotal role in encouraging digital payment transactions in the country as well as introducing new initiatives related to digital payments in the market. In the past, the Government has made direct budget allocations for boosting digital payments and has also introduced indirect interventions such as tax exemptions, caps on pricing structures, and other measures to discourage cash-based payments.

In Union Budget 2021–22, the Government allocated INR 1,500 crore towards the Ministry of Electronics and Information Technology (MeitY) for the promotion of digital payments. 

Allocation of INR 1,300 crore towards

various financial incentive schemes for acquiring banks to promote RuPay debit cards and low-value Bharat Interface for Money-United Payments Interface (BHIM-UPI) transactions (up to INR 2,000), which provided a boost to the acquiring segment of the payments business, in terms of promoting the homegrown payments products like RuPay and BHIM UPI. 

Allocation of remaining INR 200 crore towards

• promotion of digital payments for unorganised sectors including street vendors, sector-specific schemes, contactless payment solutions and digital payment solutions using feature phones.
• promotion of digital payment activities, including incentive schemes.
• conducting awareness campaigns and capacity building to increase the penetration of digital payments in the market.

Other initiatives such as tax audit exemptions for businesses based on digital payments usage were also announced.

In addition, the provision of INR 15,700 crore to the micro, small and medium enterprises (MSME) sector has improved financial inclusion for MSMEs, especially in the rural regions.

Another focus area of Budget 2021–22 was the development of a FinTech hub at the Gujarat International Finance Tec-City (GIFT), which is the country’s first International Financial Services Centre (IFSC). The International Financial Services Centres Authority (IFSCA) FinTech lab has been inaugurated and aims to connect the FinTech firms in GIFT. Furthermore, the Department of Economic Affairs has approved the FinTech Incentive Scheme 2021 to strengthen the innovation ecosystem at GIFTIFSC. An amount of INR 45.75 crore was allocated for the same over three years. 

Compensation for revenue loss due to zero merchant discount rate (MDR) on UPI

There was an introduction of the zero MDR for UPI and RuPay debit cards in the policy announced by Finance Minister Nirmala Sitharaman in 2019. The policy stated that there would be no MDR charged on UPI and RuPay payment modes. This was done to promote the acceptance of digital payments among merchants. However, it was contested by various players in the ecosystem, citing the loss of revenue as a major deterrent for their optimal functioning of the industry and making required investments to process the growing volumes. In order to take care of the industry expectations and to provide support to industry players, a part of the allocated amount is expected to be used for the reimbursement of zero MDR for UPI and RuPay debit person-tomerchant (P2M) transactions.

Below are some of the areas where the INR 1,500 crore fund may be utilised:

• reimbursement for UPI/RuPay to make good the zero MDR policy
•  topping up the INR 1,500-crore fund set aside for the Payments Infrastructure Development Fund (PIDF) operationalised in 2021
• further developing digital payment infrastructure/promoting innovations in tier II and III cities that have witnessed significant growth in the past couple of years

In 2021, the transaction value for UPI stood at ~70 trillion.² Of this transaction value, P2M transactions are valued at ~40% which amounts to INR 28 trillion. This essentially equates to ~ INR 750 crore to be refunded in the form of MDR for UPI only (assuming a flat average MDR rate of 0.25% irrespective of transaction value). Approximately, INR 1,000 crore may be spent on refunding banks for P2M transactions for UPI and RuPay for FY 2021–22. It is, therefore, likely that a majority of the INR 1,500 crore earmarked for digital payments would be allotted towards compensating for the losses incurred by the industry due to the zero MDR policy.

More funds may be required to compensate for the RuPay transaction losses and for promoting the digital payments infrastructure.

Setting up merchant-acceptance infrastructures for digital payments

In addition to the MDR reimbursement, the remaining amount would most likely be allocated to measures like topping up the PIDF fund set up by the RBI and/or setting up centralised processing infrastructure for UPI processing by banks/PSPs. The PIDF is being used to install up to one million physical point of sale (PoS) and three million digital PoS machines in rural India (tier III–VI cities).

While the regulator is targeting to set up three million acceptance points, there remains a large gap with approximately 30 million MSMEs in rural regions that could benefit from digitisation.

Another plan could be to set up a centralised cloud-based infrastructure for the processing of UPI transactions. This would cover switching, fraud and risk, which are quickly scalable at the central level without banks having to make significant investments to process the fast-growing number of UPI transactions.

Encouraging digital payments for toll collection

The National Highways Authority of India’s (NHAI) electronic toll collection system is paying an MDR of 3–4% on FASTag collection, which is considerably higher than the majority of the other payments modes, including cards. The toll industry has witnessed a 2.5–3% decrease in MDR, and acquirers have to bear the majority of the losses, with bidding as low as 0.3%. In the current year, (Apr’21 to Feb’22), INR 339 billion³ was collected through FASTag, out of which MDR accounted for INR 800– 900 crore. Here, the acquirers can be compensated up to 0.5% of the toll collection for promoting FASTag adoptions, amounting to approximately another INR 150 crore.

If state governments consider installing FASTags on approximately 500 state highways and assuming INR 30 crore is collected from each highway in a year, an amount of INR 15,000 crore would be added to the total toll collection. Therefore, if acquirers are compensated 0.5% of the toll collection to achieve the target of 500 tolls, the Government can allocate approximately INR 75–100 crore for promoting the digitisation of toll collection on state highways.

Investing in marketing, awareness and innovation

Marketing and awareness campaigns by the Government and the industry are the key pillars for encouraging digital payments initiatives in the country. Given that the industry has spent more than INR 2,000 crore on the promotion of digital payments and incentives to improve uptake over the last two to three years, it can be expected that a marginal share of 5–10% of the Government’s INR 1,500 crore expenditure may be allocated for such campaigns.

Central bank

The central bank has a key role to play in implementing CBDC in the country. This would require a secure and resilient digital rupee management system in place which can onboard commercial banks onto it while having additional features mentioned below:

• issuance and exchange of digital currency against cash reserves for banks
• minting, burning and transfer of digital currencies across wallets
• interoperability with other payment rails, dashboard for monitoring
• sandbox testing, pilot testing, roll-out of CBDC.

Additionally, the central bank needs to define regulatory, operational standards for the digital rupee and monitor to ensure its compliance with set regulations

Commercial banks

Although several different areas of banks will be impacted by CBDC, given below are four key areas for consideration:

• Technology
  • Banks need to be prepared for CBDC as an additional payment rail. Irrespective of wholesale or retail CBDCs, banks will play a crucial role in the ecosystem. Thus, the existing technology stacks need to be ready to integrate with a distributed ledger, in order to offer a seamless experience to the customers. 
  • Banks will need to be able to onboard the central bank digital rupee management system to request CBDC as per the requirement of its end users.
• Operation
  • Banks will have to facilitate customer onboarding to CBDC wallets to use the digital rupee. This will require KYC verification, time and effort and at the same time, awareness and customer education. 
  • In a two-tiered setup, the bank is the point of contact for the end user. Hence, a robust customer grievance redressal system needs to be implemented.
  • Different branches of a bank can be made responsible for the customers under its area of operation, in order to facilitate and support customers for onboarding, servicing and other activities like dispute resolution related to CBDC. 
  • Banks need to monitor and be cautious about a sudden spike in withdrawal or transfer of a large volume of CBDC, as this poses a risk and could lead to a massive outflow in a short amount of time. Also, there needs to be a system in place to alert central banks of a possible run-on-bank scenario in such a situation. 
  • Periodic regulatory reporting of the CBDC will also have to be considered by banks.
• Product innovation
  • Banks will have to envision service offerings, such as a wallet, to store CBDC as a custodian or deposits, ease of conversion of CBDC to electronic currency, or even cash for corporates/institutions. 
  • Banks can introduce new products and services on top of the CBDC infrastructure, such as a mobile application for customer touchpoint to DLT, cash withdrawal at an ATM using CBDC and interoperability between customer’s digital money and other digital assets (which can lead to a new revenue mode generation). 
  • CBDC can provide banks with a huge opportunity to automate security in cases of payments on delivery and collateral management of securities to reduce cost and time. Liquidity improvement, margin expansion, data analytics and monetisation are other avenues that can be explored.
• Upskilling
  • A bank needs to ensure that its staff is well aware of CBDC and the underlying technology and is able to then make the customers aware of the same. This will help to avoid any confusion among the customers and spread the right information. Furthermore, it would boost the bank’s trust and reputation among existing and potential clients.
  • Banks also need to make sure that their employees are fully aware and able to use new applications which are rolled out by the central bank for managing the digital currency at the bank/branch level.
  • Workshops and training on upcoming technologies and how they will impact the bank’s ecosystem and its employees’ future have become crucial in today’s time.

FinTechs/Technology vendors

• The DLT infrastructure for a peer-to-peer transaction is relatively new in the Indian ecosystem. Thus, attaining scalability and efficiency is quite critical.
• Digital rupee will require the development of a DLT network, which will have to coexist with the existing payment modes. FinTech and technology providers specialising in blockchain/DLT would thus be required to help in developing payment rails and suitable products supporting CBDC.
• Additionally, at a commercial bank-level integration of banks, a CBS with digital currency management system would be required along with modification in other channels like eBanking, mobile app, transaction sourcing, reporting, etc. This will create a demand for external technology providers.
• The interoperability between the fiat currency and CBDC needs to be seamless to have a greater reach and acceptance among end users.

Merchant

• Merchants play an important role in small-value payment in India. Therefore, their participation is a must in the adoption of the digital rupee. However, merchants will have to enable prevailing acceptance modes to accept CBDC as a mode of payment.
• Establishing an alternate mode of payment acceptance requires a merchant to integrate CBDC in the payment gateway, or simply have a QR code to scan and pay at a physical store.

Customers

• CBDC will be an ‘additional’ option for customers. They will have to secure a digital wallet from a bank or financial institution to store and utilise the digital currency and set up their security credentials to access it.
• For CBDC to have widespread adoption, it will be imperative that customers are educated, and the overall value proposition is attractive to them. A possible solution for this could be to offer discounted pricing when a customer makes a payment using the digital rupee for increasing the uptake.
• Customer convenience and a simple user interface would be required to make CBDC user-friendly.
• Given the high volume of digital transactions (e.g. UPI), the cost of operating should be such that the fees on such transactions are affordable to the banks, merchants as well as customers.