Subsising MDR is a masterstroke by Indian government

Last Friday (16th December 2017) the Indian Government announced that from January 1 2018 it would absorb the merchant discount rate (MDR) on transactions up to and including ₹2,000. This is provided payment is made using debit cards, the unified payments interface (UPI) and the Aadhaar-enabled payments system (AEPS). It is planned to be in place for two years.

Following this announcement there were many discussions, with people focusing on the ‘lavishness’ and ‘recklessness’ of the initiative, and the loopholes people were ready to exploit.

However, we think the initiative is, just as demonetisation was, a masterstroke.

It won’t cost the government much

The Central Bank recently capped merchant discount rate (MDR) at 0.9% – that means for each transaction, the government will subsidize a maximum ₹18 (about US$0.28).

The government expects the initiative to cost them (in terms of reimbursements made to the banks)  ₹1,050 crore (US$ 164 million) in FY 2018-19 and ₹1,462 crore (US$ 228 million) in FY 2019-20.

To put things in perspective, the government revenue in the 2017-2018 budget is ₹1,227,014 crore (US$191.7 billion). The budgeted spending on social welfare is ₹39,382 crore (US$6.15 billion).

So, when put in perspective, the MDR reimbursement is not a huge amount.

Loopholes, but so what?

You can’t design a system to be perfect – what you do is find loopholes along the way, and fix them as you go.

Similarly, when Aadhaar was first introduced we spoke with the people in charge, and it was treated as a self-correcting system. “India is such a big and complicated country where you do not expect things to be perfect at the onset,” one senior official once told us. “Otherwise you will never start.”

Tax collection

Combining the introduction of GST with the demonetisation initiative and other tax reforms, the government is clearly aiming to increase revenues through tax collection.

Digital transactions are growing from ₹2.18 trillion in 2016-17 and are expected to reach ₹4.37 trillion in 2017-18. Growing the digital economy is crucial to maintaining current growth.

Incentivising consumers and merchants to use cashless payments will kill two birds with one stone: helping to drive cashless and online payments, while at the same time providing a greater papertrail for transactions and reducing tax avoidance.

Overall the push towards a cashless or a less-cash society will give the government better insights into the economy, which in turn helps them plan their fiscal and monetary policies.

As with demonetisation, the true benefits may not necessarily be immediately evident.

Of course, the masterstroke is currently only a plan – how well it is executed (and how they can counteract the loopholes) pretty much determines how successful it will be.

—

Thanks for reading The Low Down, insight and inside knowledge from the team at Momentum Works. If you’d like to get in touch with us about any issues discussed in our blog, please drop us an email at [email protected] and let us know how we can help.