https://www.economist.com/special-report/2023/05/15/a-digital-payments-revolution-in-india

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[                    ]
Cashless talk

Report: Cashless talk

View all chapters
Special report | Emerging markets

A digital payments revolution in India

How emerging economies from India to Brazil built alternative
payments models

[20230520_SRD002]
May 15th 2023
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Take a walk on Mumbai's Juhu beach and little has changed in five
years--except for the QR codes adorning every food stall. Go to Sao
Paulo in Brazil, Beijing in China, or many other cities across the
emerging world and you find something similar. "Most people only want
to use UPI," says Govind, a seaside-snack vendor at Juhu, referring
to India's fast-growing payments network.

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The Unified Payments Interface (UPI) is a platform that allows free
and fast account-to-account transfers using fintech apps such as
PhonePe or Google Pay. Unlike Alipay in China, it is open, so users
are not locked into a single company and can take their financial
history to competitors, notes Praveena Rai, the chief operating
officer of the National Payments Corporation of India (NpCI), which
manages the platform. And it is facilitated by QR codes or
easy-to-remember virtual IDs.

UPI is drawing attention from across the world. "Look at what India
has accomplished with the UPI, Aadhaar and the payments stack,"
Sundar Pichai, Google's CEO, has marvelled. Overall, it processed
over $1trn in transactions in 2022, equivalent to a third of India's 
GDP. It was bolstered by the government's surprise "demonetisation"
of 2016, when multiple high-denomination banknotes were discontinued.
UPI also benefited when covid left consumers scared of cash. It has
grown from around 17% of 31bn digital transactions in 2019 to 52% of
88.4bn transactions by 2022. "India leads the world in real-time
digital payments by clocking almost 40% of all such transactions,"
Narendra Modi, the prime minister, has boasted.

The Indian model is inspiring others. Brazil's Pix, which facilitates
bank-to-bank payments with a small fee, was launched in November
2020. It now accounts for some 30% of Brazil's electronic payments
(credit and debit cards take up around 20% each). Such open
instant-payment systems are an alternative both to the bank/card
model in the rich world and to the closed fintech one in China. "What
we have shown is that it doesn't cost that much to move money if your
network is well designed," says Nandan Nilekani, co-founder of the
Indian tech giant Infosys, and an architect of India's "digital
stack", including UPI.

An even bigger prize than efficiency is the chance to supercharge
development. Raghuram Rajan, a former Reserve Bank of India (RBI)
governor, notes that digital payments generate real-time data on
sellers' businesses and buyers' purchasing habits. That allows
lenders or insurers to reach customers who may have neither the
financial history nor enough assets to participate in traditional
finance. As Patrick Collison of Stripe, a payments firm, puts it,
"The provision of credit is more socially valuable the less legible
the creditworthiness of the borrower."

Digital development

Digital forms of money have long been a source of progress in
emerging markets. In 2007 M-PESA, a mobile-money service, was
launched in Kenya by the telecoms giant Safaricom. Users give cash to
designated agents to top up an account linked to their phone's SIM
card. Payments are sent by SMS to friends, family or retailers. 
M-PESA is now used by over 90% of Kenyan households. It makes it much
easier than before to send money to relatives over distances.
Consumer spending tends to go up when money can be moved with less
friction. Academic estimates suggest that M-PESA has reduced extreme
poverty in Kenya by at least 2%.

In China Ant Group, which was spun out of Alibaba, an e-commerce
giant, and its fellow payments firm, WeChat Pay, have largely
digitised the payments business. Once the fintech behemoths have
lured consumers, they can offer loans and other financial services,
helped by algorithms that gobble up data. More than 90% of digital
payments in China now occur on these two apps. Before the recent
government crackdown, Ant was involved in over 20% of Chinese
short-term consumer credit. But Chinese fintech firms have had
several high-profile clashes with the government: Ant's planned
flotation was blocked and the lending of fintech firms was forced to
shrink. Yet Christopher Beddor of Gavekal Dragonomics, a China-based
research firm, says the worst of the attack on tech is over. In
December 2022 Ant won approval to raise $1.5bn in capital.

The Alipay model is being widely copied elsewhere. PayTM, an Indian
fintech giant that listed publicly at a value of nearly $20bn in
2021, has tried to replicate Alipay by creating a similar closed
fintech ecosystem in India. It counts Ant as one of its biggest
investors. Grab and Gojek, two South-East Asian superapps, have
pursued similar attempts at digitisation.

The benefits of digital finance tend to be bigger in emerging
economies than in the rich world, says Saurabh Mukherjea of
Marcellus, an asset manager. That is because people in rich countries
already have access to most modern financial services through
well-kept record systems, as well as assets that can be
collateralised. The hope is that UPI and similar systems might now
let some poorer countries leapfrog the West. The Indian government
has given nearly all households a bank account in a scheme called
"Jan Dhan Yojana" that is making UPI far more accessible. New
payments systems may even foster a credit boom. EY, a consultancy,
says that fintech lending in India reached $270bn in 2022, up from
just $9bn a decade earlier. This could be supercharged by the Account
Aggregator scheme, which, like open banking in Europe, allows users
to carry their financial history to a competitor.

Open payments systems may not produce another giant with the clout of
Ant in China. Alipay charges 0.1% for withdrawals above a certain
threshold. Retailers pay an average of 0.55% in transaction fees. Its
lending division once made comparable revenues. That open payments
reduce the likelihood of a similar Indian giant emerging is partly by
design. "Without UPI we'd get something like Ant without the tools to
deal with it," says one Indian grandee, referring to the inability of
the government to curb monopoly abuse.

State support has been critical to the open platforms' success.
Chinese fintechs thrived partly because of scant regulation. India's
central bank has heavily promoted UPI, even requiring retailers above
a particular size to accept it. It also mandates zero fees and
subsidises participants. Brazilian banks are similarly mandated to
offer Pix. Though it is not free, its fees average only around 0.2%
for traders, compared with over 2% for credit cards.

Competitive advantage

Boosters of India's system like noting that UPI promotes competition
among fintechs and banks. Consumers want to use the most accepted
payment systems; retailers similarly need access to the widely used.
That is why card networks or closed systems often end up favouring a
few players. Visa and Mastercard dominate the rich world, as Alipay
and WeChat Pay dominate China, giving them huge market power. The
architects of UPI and Pix see their models as breaking such a trend
to concentration. "We see UPI as a public utility," says Ms Rai of 
NPCI.

Yet the state-led, zero-fee model has downsides. Indian bankers claim
that a shortage of revenue has dissuaded banks and fintech firms from
investing in consumer protection. "There are tech costs, maintenance
costs, fraud and dispute costs," complains one. "Why would a
financial firm incur all those expenditures when there's no revenue
stream?" asks Ajay Shah of the XKDR Forum, a think-tank in Mumbai.
"This is a wake up call...maybe the answer is to charge a little more,"
says Mr Rajan, the former RBI governor.

Ms Rai counters that UPI's zero cost boosts economic growth. The
government compensated banks and some fintechs with just over 2,000
crore rupees ($250m) in 2022 as a subsidy for their public service in
sustaining UPI. But that is a paltry 0.025% of the total value of
transactions, and also far less than what it costs to run the UPI
system, reckons one banker. Despite calls either to allow fees or to
raise the public subsidy, India's 2023 budget will cut it by about
25%.

[20230520_S]

Customer protection has suffered. A survey by Renuka Sane, an Indian
economist, and her co-authors, found that 18% of UPI users had some
grievance with the system, such as fraud or a mistaken payment. Less
than 30% have seen their complaints resolved. Uttam Nayak, a former
boss of Visa in India, notes that, although UPI has rapidly growing
volumes, the overall transaction value has not taken off as much.
Consumers prefer safer payment methods for big-ticket items. "I use 
UPI to buy chai. But I wouldn't use it for a plane ticket," says one
architect based in Mumbai.

There are other flaws with UPI. Transaction success rates, a key
metric that can encourage more spending, are lower than for payment
systems in developed markets. Financial-data sharing, which promotes
competition among banks and unlocks access to credit, has been slow
to take off. Sahamati, an association of account aggregators, finds
that the number of linked accounts has grown to 5m in April 2023. But
that is small when set against India's vast population.

Developing UPI will require more investment. Ms Rai notes that it
offers a useful customer-acquisition channel for banks and fintechs
that could benefit from its massive amounts of data. "We see digital
payments as a way to onboard customers," says Harshjit Sethi,
managing director at Sequoia India, a VC firm. "Then you layer other
financial services around them...like the holy grail of lending."
Sameer Shetty of Axis Bank, one of India's largest, says that
"Account aggregator is where UPI was in 2017."

But such change can happen only if the fintechs are let in. BharatPe,
one leading Indian fintech, has a lending licence. Others such as Pay
TM, Google Pay and PhonePe do not. Politics could get in the way. A
paper from the RBI in August 2022 looked at fees for larger value
payments. Insiders familiar with the NPCI, the RBI and the finance
ministry say the first two are open to transaction fees, but the
government has all but shut the door on the idea.

No instant-payment system is perfect, but UPI is a clear improvement
on cash

Will state-directed entities be able successfully to maintain such a
technologically advanced payment system? "What you want is for the
market to churn rather than picking winners," says Mr Shah of the 
XKDR Forum. "UPI was central planning." Even those who champion UPI
see a need for multiple payment options. One grandee talks of
"concentration risk". They note that "If NPCI goes down, then the
whole payment system goes down," adding that there "could be a role
for a second NPCI."

No instant-payment system is perfect, but UPI is a clear improvement
on cash. In March the RBI launched UPI for feature-phones equipped
with buttons, not touchscreens, which could expand access to the
system. And it is spreading abroad. Already UPI is integrated with
Singapore's payments system, letting people send remittances with a
relatively low 3% fee. India wants UPI to become a payment option
abroad, just as Alipay is widely accepted outside China. Ms Rai says
other countries may even adopt the entire UPI stack. Mr Nilekani
hopes UPI will eventually be used everywhere. "If I go to Lulu in
Dubai or Harrods in London, I should be able to make a payment with 
UPI." That would surely create new competition for the bank/card
behemoths in the West.#

This article appeared in the Special report section of the print
edition under the headline "A payments revolution"

How should America lead? The Biden doctrine and its flaws

From the May 20th 2023 edition

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