Digital payments in India will reach $1 trillion by FY26, estimates CLSA

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The value of digital payments in India will grow three-fold from $300 billion in FY21 to $0.9-1 trillion in FY26, led by an increased adoption and rapid growth in Unified Payments Interface (UPI) transactions, according to a report by CLSA.

Retail commerce digital payments contributed 10.7 percent to India’s gross domestic product (GDP) in FY21 and, as CLSA estimates, this will to reach 20.3 percent in the next five years.

“With rising UPI use, digital payments have risen from $61 billion in FY16 (6 percent of consumption GDP) to $300 billion (18 percent of consumption) in FY21. UPI currently contributes 60 percent to the total payments by volume,” said the report.

Since the beginning of the pandemic, UPI payments have seen aggressive growth led by an increase in online purchases and a preference for digital payments over the exchange of cash.

Since its inception in 2016, the value of monthly UPI transactions took four years to cross the Rs 3-lakh-crore mark in September 2020. A year later, it more than doubled to Rs 7 lakh crore.

In the overall value of payments made to merchants, UPI transactions almost equalled the debit and credit card transactions. According to CLSA estimates based on transactions in the first half of FY22, UPI transactions at $187 billion are close to surpass $83-billion debit card transactions and $102-billion credit card transactions.

However, while UPI remains the driving force for digital payments in India, it generates no revenue for ecosystem players like banks and fintechs like PhonePe, Google Pay and Paytm Payments Bank. This is because of the Zero Merchant Discount Rate (MDR) policy of the government which mandates that merchants should not be charged for accepting payments from customers through UPI (and RuPay debit cards).

On the absence of a viable revenue model in the payments space, CLSA said: “Payment platforms have built huge scale on the issuing and acquiring side; what’s key for them is the ability to diversify and monetise their customer and merchant base.”

Around 47 percent of all payments by customers in FY22 are estimated to be made through UPI, and only 6 percent through mobile wallets.

On the merchant side, CLSA expects that in FY26, around 44 percent of payments will be accepted through payment gateways and aggregators, followed by 34 percent through QR Codes and 22 percent through Point of Sales (PoS) machines.

Payment gateways and aggregators are expected to grow at a fast clip with the Total Payments Value (TPV) growing three time from $170 billion to $550 billion in the next five years.

On December 8, as part of its Monetary Policy Statement, Reserve Bank of India Governor Shaktikanta Das said that the regulator will float a discussion paper on digital payments. It will look at charges involved in various channels such as credit cards, debit cards, prepaid payment instruments (cards and wallets) and UPI.

Das said that charges levied across digital payment modes must be reasonable and affordable. Digital payments must also remain “economically remunerative” to payment service providers. More is awaited on the RBI’s plans.

‘Buy Now Pay Later’ to Grow 5-Fold

The report projects the digital lending or the Buy Now Pay Later (BNPL) market in India will grow five times from $15-20 billion in FY21 to $90-100 billion by FY26. With this jump, BNPL is expected to represent 10 percent of digital payments by FY26.

Over the past two years, BNPL or the equated money instalments (EMI) method of lending are increasingly emerging as a payment mode, rather than only a lending product. This is led by a rise in the embedded financing model adopted by digital lenders, which allow customers to choose a pay-later option while checking out on e-commerce sites.

CLSA said that affordability-enhancing features and ready availability of credit will help fintechs to stay at the forefront of growth in personal loans in India. Fintechs in the digital BNPL space include Simpl, ZestMoney, PayU’s LazyPay, Capital Float and Mobikwik Zip.

“BNPL has been a high-delinquency product and underwriting will be a differentiating factor. In addition, we expect some regulatory tightening on risk transfers and use of first-loss guarantees,” the note said, referring to the RBI’s plans to introduce guidelines for digital lending.

First loss default guarantee (or FLDG) refers to agreements between BNPL fintechs and their lending partners where the fintech promises to compensate the partners up to a pre-decided percentage in case customers fail to repay the loans. A report by the RBI working group on digital lending has listed FLDG as a concern as most of these charges are passed on to customers.

Small-ticket personal loans have seen a significant increase over the past few years, led by a huge appetite for credit and customers choosing BNPL over credit cards. “With the rapid expansion, small-ticket personal loans contribute 60 percent of the overall personal loan volumes, while fintechs contribute 45 percent by number. More than 70 percent of personal loans are originated outside tier-1 cities,” CLSA said.

The market of super-prime and prime customers is still dominated by credit card players with fintechs enjoying only a 13-18 percent share. But the ease of securing loans is changing this with fintechs raking in more prime customers.

CLSA sees fintechs leading the expansion of the credit market in India and driving penetration with a 50 to 60 percent share of new to credit and sub-prime customers.