UPI or how digital payments got India going

This photo has become a common sight nowadays in India. Wherever you look, there is a small merchant (sometimes simply a fruit cart) accepting digital payments for amounts as small as one rupee (1/88^th of a Euro). The QR code in the picture allows customers to transfer the money to the merchant’s bank account through one of the fastest, most secure, and cheapest ways one can find around the world. It is also one of the biggest breakthroughs by India’s economy in recent times: The development of one of the best pieces of public digital infrastructure worldwide, labeled Unified Payments Interface or UPI.

India is a country where barely 4% of the population owns a credit card (compared to high double digits for most developed countries). Debit cards are more prevalent but still have a low usage rate. The reason for this is the cost and accessibility of these traditional methods. The fees for the traditional card network usage (what is known as the Merchant Discount Rate or MDR) are too high for most Indian small merchants. The barriers to entry are also too high for users to obtain a credit or debit card (no credit score, banks not interested in low-income customers, etc.) In the past, this led to an economy with lots of circulating cash and unrecorded transactions.

In 2009, the government of India embarked in the first key project to bring hundreds of millions of citizens into the formal economy. The Adhaar card created a digital identity proof and made it very fast and easy for any step that requires it. For example, opening a bank account (in 2 minutes) or purchasing a phone data plan. Today, close to 1.3 billion Indians have an Adhaar card.

Second, in 2016, Reliance Jio flooded the telecommunications market with aggressively cheap data plans (bringing the cost of data in India to one of the lowest in the world) and smartphones (the latter also aided by government subsidies). This resulted in 600 million Indians with a smartphone and lots of cheap data to consume on it. Interestingly, the Adhaar card development played a crucial role, as Jio would not have been able to onboard so many customers (e.g., 100 million customers in the first six months after launching) so fast without quick and costless identity proof.

Third, also in 2016, the government launched the Unified Payments Interface (UPI). UPI requires only a bank account and a phone number of each side (buyer and seller). A payments aggregator app (Google Pay, PhonePe, Paytm, AmazonPay, BHIM, etc.) enables the buyer to quickly connect with the seller through a QR code or his/her phone number and make an instant payment from bank account to bank account (every account is linked to the user phone number). The payment is settled instantly and, best of all, comes at zero cost for the buyer and the seller. Therefore, with UPI, anybody can pay anybody with just a bank account and a phone, with no minimum amount limit (the maximum amount for now is set at 100,000 rupees, about 1,120 euro). The user experience of using any payments aggregator app is seamless and even allows for the buyer and the seller using different apps. Though UPI is a public good (designed and maintained by a government agency), the aggregator app is a highly competitive space, with many private tech companies (Google, Amazon, Paytm, and many local fintechs) jostling for share. Why? Because everybody is using UPI and thus UPI becomes a great tool for acquiring customers that can be monetized later with other products. 

So we have hundreds of Indians that were using cash because the traditional payment tools were too costly and/or out of reach. And now, thanks to UPI and the tech companies, they have a free and fast method to pay. The result, an explosion in the number of users of UPI (260 million and growing very fast), overcoming any other method in a very short time. Today, UPI manages a volume of $1.57 trillion in annual transactions and enjoys a share above 65% of total payments while debit and credit cards’ percentage has shrunk to 9%. It is the preferred payment method for both Peer to Peer and Peer to Merchant. And it is extending in all directions, soon enabling UPI payments with debit and credit cards and also payments from outside India. Imagine all the remittances from Indians abroad (which have an annual volume larger than the foreign direct investment in the country) done at cost zero (compared to around an average 6% fee currently).

The biggest consequence of UPI growth has been the new access to financial services for hundreds of millions of middle- and low-income Indians and their entry into the formal economy. This means, for example, that small merchants (i.e., the corner shop, the fruit stall, the small business) have greatly increased their options for obtaining credit to manage or expand their operations (mostly from fintechs eager to tap into such large new market). Similarly, middle- and low-income users have gone from not having any credit option to having, for example, a host of services offering small-ticket consumer loans. This increased financial inclusion results, obviously, in a multiplier effect for economic growth (increased consumption, increased consumption, etc.) It is estimated that UPI will add more than one percentage point to India’s GDP growth by 2026 (in 2021 it already added 0.56%).

UPI has also brought an enormous number of transactions out of the shadows of the informal cash-based economy. This has contributed, for instance, to a steady increase in the number of Indians and businesses who pay taxes (which currently is an extremely small number, for example, only 70 million pay income tax). It also puts many many transactions on digital record, which, with the user consent, can then be leveraged into offering better credit services to businesses (especially) and customers.

Last but not least, the success of UPI has led to the Indian government's belief that it can repeat it. Many other pieces of digital infrastructure, many of them linked directly to UPI, are being designed and tested right now. The Account Aggregators platform will digitally compile and keep key financial and personal information that users can allow to be accessed with a click by financial services companies willing to offer insurance, credit, and many other services. The Open Network for Digital Commerce (ONDC) will attempt to break the monopolies of e-commerce giants like Amazon by offering a free platform for small businesses to reach the consumer. The National Health Stack will connect consumers and the full medical services value chain. And so on and so forth.

The UPI story is just beginning but it is already oversized in its effect on India’s growth.