Union Budget 2026: UPI's 'Mega-Crisis': Will Budget 2026 Save Digital India? What's Nirmala's Plan?

India's Unified Payments Interface (UPI) digital payment system, which has revolutionized transactions across the nation, now stands at a crucial juncture. Ahead of Budget 2026, the biggest question facing the country's leadership and Finance Minister is the long-term sustainability of this transformative platform, while while UPI has recorded unprecedented transaction volumes, its zero Merchant Discount Rate (MDR) policy is imposing significant financial strain on payment companies and banks, raising concerns about their continued growth and operational capacity. This situation presents a serious challenge to the future of Digital India, necessitating immediate and decisive policy intervention to safeguard its progress.

The UPI Revolution and its Hidden Costs

UPI has undeniably transformed the payment landscape in India. From a 10-rupee cup of tea to a 50,000-rupee smartphone, or paying electricity bills and rent, plastic cards and paper currency are gradually becoming obsolete, while google Pay, PhonePe, and other UPI-based platforms have become an integral part of daily life, especially since demonetization and the pandemic, which rapidly propelled the country towards contactless transactions. However, behind this success story lies a growing unease, which industry leaders assert policymakers can no longer ignore, while this unease stems from the hidden costs of processing UPI transactions, which are currently borne entirely by banks and fintech firms without any corresponding revenue stream.

The Financial Burden of the Zero MDR Policy

The central government's emphasis on zero MDR for UPI and RuPay debit card transactions, particularly for low-value person-to-merchant payments, has undoubtedly boosted financial inclusion. It has helped extend digital payments to a broader population, but the financial burden of this policy is now becoming unsustainable. According to the Reserve Bank of India, processing each such transaction costs approximately 2 rupees, while this cost is entirely borne by banks and fintech firms, forcing them to provide an essential public service without any income. A government release issued by PIB states that the expenditure incurred by the digital payment industry to provide services to customers/merchants is recovered through the Merchant Discount Rate (MDR), which is the fee merchants and other businesses pay to the payment processing company for debit or credit card transactions, while zero MDR means this recovery isn't possible, putting immense pressure on the entire ecosystem.

Signs of Stagnation in Merchant Expansion

Despite rapid growth in transaction volumes, there are alarming signs of fatigue in UPI's merchant expansion. According to analyst data, the growth rate of the active merchant QR network has been only about 5% CAGR over the past three years, which isn't commensurate with the increasing demand for digital payments across the country. Plus, its widespread penetration is lacking. Even today, only about 45% of India's merchants accept UPI payments on a. Monthly basis, indicating that a large segment remains untouched by this digital revolution. This limited acceptance rate is a major impediment to realizing UPI's. Full potential, and the underlying financial instability could be a primary reason.

Uneven Geographic Penetration

The geographical spread of UPI is even more striking in its unevenness. Approximately one-third of India's pin codes have fewer than 100 active UPI merchants, and about 70% have fewer than 500, while each pin code has an average of over 2,500 merchants. This disparity between potential and reality clearly highlights the growing pressure on the system. It indicates that UPI's reach is still largely confined to urban and semi-urban areas, with very low penetration in rural and remote regions. Addressing this imbalance requires massive investment in infrastructure development and. Merchant acquisition, which appears unfeasible under the current zero MDR model.

Growing Concerns from the Industry

Payment companies, banks, and fintech firms have consistently warned that the model supporting UPI's growth is becoming increasingly unsustainable. The Payments Council of India (PCI), representing non-bank payment system participants, has expressed concern that while government incentives were crucial in driving initial adoption, the current framework doesn't provide a viable long-term revenue model for companies building, maintaining, and securing payment infrastructure. This situation creates significant challenges for these companies to sustain their operations and invest in the future, potentially slowing down the pace of innovation and expansion across the digital payments landscape.

RBI Governor's Indications

The Reserve Bank of India has also echoed these concerns. RBI Governor Sanjay Malhotra has emphasized that while UPI has provided immense public benefit, its long-term viability depends on someone paying for its underlying costs. Malhotra stated that there are certain costs associated with UPI transactions, and someone has to pay them. He stressed that for the stability of the model, it's crucial that someone, collectively or individually, pays the bill. Earlier this year, speaking at a financial sector summit, the central bank chief said that UPI is a critical infrastructure that the government has deliberately chosen to keep free for users by subsidizing it – a policy that has yielded rich dividends in terms of usage and will continue to do so. However, he also hinted that this model can't remain free indefinitely.

Inadequacy of Incentive Packages

PhonePe, one of India's largest UPI platforms, has acknowledged that the mandatory zero MDR rule in its current form isn't economically viable. According to the company, the ecosystem urgently needs a predictable cost recovery mechanism to remain sustainable at scale, whether through Merchant Discount Rate (MDR) or adequate government subsidies. The fintech giant noted that the incentive package of 3,900 crore rupees disbursed in FY 2023-24 was insufficient to cover operational costs, and this support further decreased to merely 1,500 crore rupees in FY 2024-25. A PhonePe spokesperson, speaking to ET, stated that this allocation is far less than the amount required for building technical infrastructure, onboarding consumers and merchants, driving education initiatives, and implementing strong risk and fraud prevention systems for UPI.

Lack of a Long-Term Revenue Model

The PCI has stressed that sustaining long-term investments in payment processing, customer acquisition, and operational management remains a serious concern. The existing incentive structure isn't a sustainable revenue model, putting the existence of many fintech companies in severe jeopardy without adequate support, while this situation could stifle innovation and reduce competition in the digital payments sector. Without a stable revenue stream, it becomes difficult for companies to invest in new products and services, which ultimately impacts the benefits delivered to consumers and merchants. The current framework, Because of this, poses a fundamental threat to the continued evolution of the UPI ecosystem.

The Challenge of Investment and Financial Gap

PhonePe, in an ET report, stated that for the current fiscal year, the government has allocated only 427 crore rupees for digital payment incentives. In contrast, it's estimated that the ecosystem will collectively invest approximately 8,000-10,000 crore rupees over the next two years, while based on the growth trajectory and benchmarking against the FY 2023-24 subsidy, the actual cost of maintaining zero MDR through government subsidies would be between 8,000-10,000 crore rupees over the next two years, and this figure will only increase with UPI's expansion. This highlights a severe unsustainability. The fintech firm further added in media reports that it's practically not feasible for the. Government to bear this cost through annual budget allocations, further emphasizing the need for a sustainable solution.

Decline in Government Incentives

This financial gap has widened rapidly despite the massive surge in UPI usage. NPCI data showed that in October alone, UPI processed 27. 28 lakh crore rupees in 20, while 7 billion payments, with an average daily load of approximately 668 million transactions valued at about 88,000 crore rupees. Due to increasing penetration in tier-2 and tier-3 cities and strong demand during festive seasons, UPI now accounts for approximately 85% of the total digital payments in the country. Despite this, budgetary support has moved in the opposite direction, while government incentives for digital payments have fluctuated wildly in recent years – increasing from 1,500 crore rupees in FY 2022 to 3,500 crore rupees in FY 2024, then decreasing to 2,000 crore rupees in FY 2025, and further plummeting to 427 crore rupees in this year's budget estimates. This decline is a major concern for the industry.

Threat to Growth Momentum

PhonePe has warned that without a substantial increase in funding, the industry's growth momentum is at risk. The platform noted that UPI has reached less than half of India's smartphone users, and expanding to. Tier-4 cities and beyond will require massive and continuous investment in both merchant acceptance infrastructure and consumer education. The company stated in the ET report that without adequate funding, both consumer acquisition and merchant onboarding in Tier-4 cities and beyond will be Importantly impacted. Consequently, payment service providers are facing increasing pressure. The rising costs of infrastructure development, customer acquisition, cybersecurity, regulatory compliance, and providing services in rural areas are clashing with an almost zero revenue model. This situation could undermine the government's goals of digital inclusion.

The Need for a Sustainable Revenue Model

The company stated that MDR doesn't mean that consumers will pay, but rather it's a mechanism that helps service providers recover their costs. Without a sustainable revenue model, the ecosystem's ability to invest in marketing, education, risk and fraud prevention, and developing solutions for the next billion users is being hampered. With no concrete source of income to offset these expenses, many companies may begin to reconsider their expansion plans and slow down the pace of innovation. This situation will ultimately hinder UPI's growth and reach, potentially dealing a blow to the vision of Digital India.

Budget 2026: A Decisive Factor

PhonePe and other industry leaders believe that the only way to break the current cycle is to implement a controlled MDR (Multi-Digital Reduction Model) framework, enabling the ecosystem to become self-reliant and allowing the government to direct public funds towards strategic priorities like infrastructure development and digital literacy. The company stated that a sustainable, market-based monetization model will make the ecosystem self-reliant. Echoing the fintech giant's sentiments, Vishwas Patel, Joint MD of Infibeam Avenues and Chairman of PCI, stated in the ET report that due to zero MDR on UPI and the mere 1,500 crore rupees previously allocated for processing such large-scale transactions, the system is deprived of the necessary funds for sustainable growth. Industry leaders were preparing to press the central government for a. Substantial increase in subsidies during deliberations for the Union Budget 2026.

Industry Demands and Future Path

According to earlier ET reports, payment operators were seeking permission to implement a controlled MDR of 25-30 basis points on payments made to large merchants (those with an annual turnover exceeding 10 crore rupees). They argue that businesses with higher transaction volumes can bear this nominal charge, ensuring the smooth functioning of the financial system. Plus, the PCI has warned that in the absence of reforms, fintech companies may soon be forced to cut back on their operations, halt rural expansion, and limit innovation, thereby harming the government's own objectives of deepening financial inclusion and extending UPI's reach to the next 300 million Indians. Nirmala Sitharaman's plan in Budget 2026 will be crucial for the future of Digital India, determining whether UPI's success story continues or faces significant setbacks.