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Finanomics – Mo Money Mo Problems

Inflation targeting and UPI Market Cap

April 5, 2021
Reading Time: 8 mins read
abundance bank banking banknotes

Photo by Pixabay on Pexels.com

Inflation Targeting

The inflation target set in August 2016 was set to end on 31st March 2021 as the 5 year period came to an end. The target of inflation through these 5 years was 4% inflation with 2% upper and lower tolerance levels, meaning inflation between 2% and 6% in the country was acceptable and the monetary policy was designed to keep the inflation limits within this target.

With the old target set to expire and the ongoing pandemic, it was expected that the Indian government would change the inflation band for the next five years. But, Tarun Bajaj, the Economic affairs secretary to the Indian Government announced that the inflation target till 2026 will be left unchanged. The Monetary Policy Committee of RBI is set to meet this week and announce the continuation of the inflation target officially.

Let’s try to understand the different parts of this story.

What is Inflation?

Inflation is the rate at which the value of a currency is falling and consequently, the general level of prices for goods and services rising. Let’s say, 100 rupees would have gotten you 10 lays packets last year, but due to inflation, for the same 100 rupees, you would now only get 9 lays packets, which is quite sad honestly and that is a very simple example of inflation. It reduces the value of money that you hold, effectively garnering fewer commodities for the same amount than you would have previously.

What is Inflation Targeting?

Inflation Targeting is a policy taken by the RBI to keep the prices stable, i.e., keeping inflation in check. Inflation targeting is important since it brings stability, predictability, and transparency in deciding monetary policy. It is the role of the RBI and Monetary Policy Committee to control deflation and inflation and stay within the inflation target. From 2016 through 2021, the inflation target was set as

Upper tolerance level – 6%
Target – 4%
Lower tolerance level – 2%

What is the role of MPC and how is inflation controlled?

Monetary Policy Committee is a committee consisting of 6 members, 3 from the RBI and 3 external members nominated by the Indian Government that dictates the monetary policy of India. The primary role of MPC is to keep the price levels stable. The monetary policy hence is dictated by the inflation target with the domestic shocks in consideration.

Some of the tools used by the RBI to keep inflation in check are:

  • Repo rate is the rate at which the central bank lends money to the commercial banks against securities
  • Reverse Repo rate is the rate at which the Reserve Bank of India borrows funds from the commercial banks in the country.
  • Cash Reserve Ratio is the percentage of a bank’s total deposit that need to be kept as cash with the RBI. The central bank can change the ratio to a limit.
  • Bank Rate is the rate charged by the central bank for lending funds to commercial banks. Higher bank rate will translate to higher lending rates by the banks.

How do these rates help?

All these different rates affect the money supply in the economy. If there is more money in the economy, the RBI tries to adjust monetary policy such that lending rates go up, effectively reducing the money circulating in the economy and bringing inflation down, at the same time RBI can also change the policy rates, such that it is easier to borrow money and RBI tries to increase the money supply in the economy.

Has this been successful?

Yes! This has been one of the major policies by the current government that has been hailed as widely successful. Here is an article from October 2020 by economist Ila Patnaik, explaining how ‘Inflation targeting has worked for India, it is one of Modi govt’s defining achievements.’ Similarly, earlier this year an RBI report showed how in the 4 years of the inflation targeting policy, (October 2016-March 2020) the CPI (Consumer Price Index) that is used to measure inflation has averaged at 3.9% between October 2016 and March 2020, which is close to the 4% target of RBI.


Competition in UPI

India over the last few years has become a force to reckon with in the fintech and payments world. Start-ups and government initiatives have been working towards creating ‘digital India.’ One such organization is NPCI (National Payments Corporation of India) – a not for profit organisation under the Reserve Bank of India that has fostered innovations that have changed the face of retail payment and settlement systems.  Bharat Bill Payment System, BharatQR, BHIM, Immediate Payment Service (IMPS), FASTag, RuPay and most importantly – Unified Payments Interface or UPI.

UPI has been the success story in India that has effectively revolutionized payments in India by making them digital, fast, cheap and efficient. Earlier this year in a post about a potential cryptocurrency ban in India, I wrote the following about UPI, “In 2017-18, UPI accounted for 9% of all retail transactions, but over time with smartphones being more popular, and internet connectivity reaching across India, online payments becoming more acceptable, we saw that by February 2020, UPI’s share for all retail transactions by volume had crossed 50%.” (yup, I quoted myself :P) UPI’s success has been such that NPCI plans to expand UPI to other countries in Asia and the Middle-East like Singapore and UAE.

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UPI infrastructure has created tremendous opportunities in the fintech business by creating a space for expansion of operations by PayTM, the launch of Tez (now google pay), PhonePe, and other companies like WhatsApp, Amazon, Samsung to embrace UPI. According to NPCI, there are 21 third party applications live on the UPI platform.

“Currently with over 500 million smartphones, 1.2 billion Aadhaar users and 1 billion mobile phones, it is possible to increase the UPI user base to five times in the next three to five years, aspiring to achieve a billion transactions a day”

NPCI Circular (March 25th, 2021)

But now, all is about to change. NPCI, last year issued a directive to bring ‘parity’ in the UPI ecosystem by capping the market share of third-party app providers to a 30% volume of transactions which became live on January 1st 2021.

Let’s understand this

  • PhonePe leads the UPI market share by volume, with 42% of all UPI transactions in February 2021 coming through the Flipkart-owned PhonePe.
  • Second in market share by volume with 36 per cent of total UPI volume in February coming from Google Pay
  • This means that currently, over 75% of all UPI transactions come from GooglePay and PhonePe.
  • This is followed by PayTM as a distant third with little over 14% of the market share.

NPCI is now introducing a market share cap, which means a third-party app has a limit of 30% of the volume of UPI transactions. If a provider exceeds the 30% limit, the app will no longer be able to onboard new customers.

NPCI is planning to cap the market share of companies to 50% for the first year, 40% for the second and 33% for the third. In other words, a PhonePe that has a 42% market share right now will have to bring it down to 33% within three years. This cap has been justified as a mechanism to keep a check on the monopolization of the UPI infrastructure.

What’s wrong with it?

  • User inconvenience – The the policy is honestly against the consumer interest, with the new restrictions in place, the customer/user is expected to know multiple applications and alternatives as a market cap would restrict a new customer/user to a less popular application upon restrictions on more popular applications to onboard customers. This is effectively taking the choice away from the user.
  • Curbs Innovation – It was through different services and features provided by PhonePe and GooglePay that they were able to create an incentive for the customer to join their platform. But, by creating a market cap in the volume of transactions, and a ban on accepting new customers upon non-compliance of market cap, the incentive on these companies to innovate or to find ways to get more people to use UPI is curbed.
  • NPCI’s authority – Some have begun to question the authority of NPCI to take such drastic decisions since it is neither a competition authority nor a regulator.
  • Another interesting point raised in an opinion post on the Mint is that “there is no basis or precedent for declaring a service, provided free of cost by all players, to be anti-competitive. UPI is free for consumers. This is a perplexing case of trying to redistribute a zero-revenue service so that no player gets more than 33% of zero.”

PhonePe chief executive officer Sameer Nigam has told the Mint in an interview that they had no plans on trying to curtail market share as they are “working to ensure more merchant partners opt for PhonePe over rival payments firms.”

UPI is an Indian success story like never before that has eased payments between all stakeholders and has received great praise from many. It would be devastating to see bureaucratic restrictions being placed in the UPI space that could hamper the user experience. Calls have been made by industry experts to the NPCI and RBI to rethink the methodology and restrictions.


This post is part of the weekly newsletter on economics, finance and public policy – Finanomics by Phani Datta. You have reached the end of the tenth edition of finanomics, thank you for reading. Please do let me know your thoughts, suggestions, feedback, or comments on the newsletter as well as the content in it. Thank you, happy Sunday! See you next week!

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Phani Datta Surampudi

Phani Datta Surampudi

I am Phani Datta, an M.A. Economics student at O.P. Jindal Global University from Hyderabad, Telangana. I follow closely and write about Economics, Finance, Technology, Business and Public Policy.

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