FDI in Retail: Opportunity and Opposition
December 1, 2011
FDI & the retail sector
Currently, the retail market is dominated by small family-run shops, with a very small portion of India’s retail market – approximately 6 to 10 percent – coming from organized sources. As a result, there is a great opportunity for both large national players as well as multinational retailers to grow their business in India. The retail market was of course transformed and made even more open to foreign companies last week when the Government of India approved 100 percent FDI in single-brand retail trading (SBRT) and 51 percent in multi-brand retail trading (MBRT). Previously, SBRT was only permitted up to 51 percent FDI and MBRT fell below majority ownership. The market first began to open in 2006 when 100 percent FDI was allowed in cash & carry operations, allowing firms like Carrefour and Wal-Mart to get a foot in the door, along with joint ventures with local companies. These operations make up almost one-third of the Indian retail sector, even as single-brand retailing has attracted a measly $44.5 million – 0.03 percent in terms of total FDI inflows – over the past five years.
The retail sector in India currently stands at about $450 billion and is expected to grow to nearly $800 billion by 2015 and further to $1,250 billion by 2020. This would take the share of organised retail to over 20 percent. Its value has more than trebled since 2005 and the sector is expected to grow at a steady 25 to 30 percent annually. Currently, there are estimated to be around 200 foreign brands in India, allowed to operate via the franchise route. Recent years have seen major expansion by big local players in multi-brand retailing. National Retailers like the Future Group, Reliance Retail, Shoppers Stop, Aditya Birla Retail and Spencers have got various private labels on board while successfully expanding to major cities and towns. According to consulting firm Technopak Advisers, large domestic and foreign retailers are planning investments of around $35 billion over the next five years.
Good news, bad timing?
The new policy will come into force in April 2012, once the Department of Industrial Policy and Promotion (DIPP), under the Ministry of Commerce and Industry, formally incorporates the new revisions. By announcing it in the middle of a stormy Parliamentary session – one in which 33 Bills were listed for business – the government has taken a huge risk by giving the Opposition another reason to stall proceedings. Because the reform was done through a policy pronouncement, the decision does not require parliamentary approval. But the issue is a highly emotive one and has already inspired significant opposition from political parties as well as petty traders and civil society activists. Some political parties are ready for a debate but most are not interested and want unconditional rollback. Since retail trade is a state (federal) subject, provincial governments are free to reject rollout.
Conditions apply
Aware of the high emotional quotient involved, and the widespread socio-economic impact of its decision on various sections of society, the new proposals come with certain riders.
SBRT
Prior to last week, single-brand retailers are allowed to establish a presence in India if they have a local partner as the major stakeholder. For months now, positive government pronouncements have broadly hinted at raising the 51 percent cap in single brand retail, along with the opening up of multi-brand retail. The current franchise-driven model and policy ambiguity had made global single-brand retailers wary of expansion. With the latest decision to allow up to 100 percent FDI in SBRT, retail giants such as IKEA, which already source over $650 million worth of goods from the country annually, are expected to set up shop in India.
The decision to allow up to 100 percent single-brand retail comes with the following riders:
- Products sold to be of a ‘single brand’ only.
- Products should be sold under the same brand internationally, i.e. under the same brand in one or more countries other than India.
- Single brand product retailing would cover only products that are branded during manufacturing.
- The foreign investor should be the owner of the brand so retail presence has to be directly through the owner.
MBRT
Opposition to FDI in retail is mostly centered on multi-brand retailing, as opposed to SBRT. Most of those who oppose multi-brand retailing view the ‘predatory’ potential of big, retail chains as being detrimental to small enterprises, local farmers and the estimated 40 million local ‘mom-and-pop’ stores on which about 200 million depend for their livelihood. Caveats for MBRT in the new proposals include:
- Global retailers exercising the 51 percent option must source 30 percent of inputs/raw materials from SMEs, including small entrepreneurs and village craftsmen. Initially, the Ministry had said this would not be restricted to India as per WTO regulations, but the procurement clause had to be tweaked after a political uproar. (Small industries defined here as those with a total investment in plants and machinery of less than $1 million).
- Only allowed to open stores in cities with a population of one million and above, as per the 2011 Census (53 cities in total). This may also cover an area of 10 km around municipal urban agglomeration limits of such cities.
- Retail locations will be restricted to areas as per the master zonal plans of the cities concerned and provisions will be made for requisite facilities such as transport connectivity and parking.
- Investors must bring in a minimum investment of $100 million (This might pose a problem to those looking to invest smaller amounts, like in the music industry –opening up the field for more JVs).
- No branding of fresh farm produce would be permitted and the government would have first right to sourcing agricultural products.
- At least half of the investment must be in back-end infrastructure, such as cold chain and warehousing. Expenditure on land cost and rental, if any, will not be counted for purposes of back-end infrastructure.
- Self-certification will be done by the company to ensure compliance of all the conditions.
- At least 30 percent of sales to be made to small retailers, either directly or through separate wholesale units.
The case for FDI in retail: Game changer?
With its decision to allow up to 51 percent in MBRT and 100 percent in SBRT, the government is looking to push domestic consumption, create jobs, moderate inflation and boost FDI inflows in an economy that has been slowing due to global financial uncertainty. Also, given that the Parliament has reached another stalemate in the Winter Session, the UPA government is trying to dispel the widespread notion of ‘policy paralysis’. Indications are that Prime Minister Manmohan Singh is willing to stake his personal reputation on holding fast on the decision, much like he did for the Indo-US nuclear deal.
India Inc has welcomed the decision, calling it a “game changer”. Cited reasons range from controlling inflation and greater market access for small producers, to boosting the rural economy. It would also, they claim, attract investment, offer better prices to consumers and producers alike, along with better technology and direct market linkages. Currently almost about 40 percent of fresh
produce is wasted from farm to fork, which can be avoided by putting in place better supply-chain infrastructure and better consolidation of back-end services. Indian farmers get only about one-third of what the consumer finally pays for their produce. This is way too less when compared to 2/3rd with organised retail, as per one estimate.
On the other hand, both foreign retailers present in Cash & Carry operations, as well as cash-strapped domestic players, stand to benefit – the former by being able to move to front-end operations. Besides its potential for transforming the retail sector, the decision is likely to be felt across other industries as well. For example, realty giant DLF has already announced plans to invest up to $600 million in developing malls across the country. Many companies are expected to follow suit across different sectors to provide support services to the retail sector. According to the Minister for Commerce and Industry Anand Sharma, the new policy carries the potential to create 10 million new jobs over the next three years.
The brewing political storm
Though the government’s policy decision does not require any changes in the law, the proposal – especially the timing of the announcement – has come under heavy political fire. The main Opposition party – the Bharatiya Janata Party (BJP), which relies heavily on traders for political sustenance, is up in arms against the decision. So are some of the government’s allies like the West Bengal Chief Minister, Mamata Banerjee-led Trinamool Congress. Interestingly, the BJP seems to have pulled a U-turn in its complete rejection of FDI in MBRT, since its 2004 election manifesto had promised opening up multi-brand retailing to 26 percent FDI. Joining cause with others like the Left Parties and a band of regional parties in power in the provinces – with the notable exception of Punjab, where Cash & Carry operations have been thriving – they are demanding an unconditional rollback.
According to observers, the government has three options before it: rollback the decision altogether; agree to a debate in Parliament, subject to voting to get a ‘sense of the House’; delay the decision till after the country’s largest state (Uttar Pradesh) goes to the polls next year. Another proposal making the rounds is to have a separate regulator for the retail sector. Yet another one suggests raising the domestic procurement component to 40 percent to mollify dissenters. For now, it seems that none of these are acceptable to the UPA decision-makers, and that the decision is here to stay. The Finance Minister has made it clear that though the decision will not be rolled back, ruling federal governments can choose not to implement it.
What now?
For now, the Congress Party, which leads the coalition government, has been able to contain the revolt within its own ranks on the issue, but it is a fragile truce. With a current parliamentary stand-off on the issue stalling legislative proceedings, the FDI decision might just have to be subsidized by the government having to strike a compromise on other issues. But the reality is that the decision to allow FDI in retail is here to stay, though the government might have to show some flexibility in the terms and conditions it has set. Foreign firms looking to enter the Indian market can now look to realign their entry/expansion strategies. Many of them feel analysts, would do well to tie up with local players initially to better negotiate Indian market conditions and ride out any further policy or regulatory uncertainty. In the meantime, the Indian consumer will have to wait a while till the hypermarket around the corner becomes a reality.
- By Preeti Singh (with inputs from Anurag Sikder); Contact: preeti.singh@9dot9.in