AAP reverses permission for FDI in multi-brand retail in Delhi

Sarah Coco

On January 13, the ruling Aam Aadmi Party (AAP) in Delhi wrote to the Department of Industrial Policy and Promotion, withdrawing permission to allow foreign direct investment (FDI) in the multi-brand retail sector in Delhi. The letter, a reversal of the previous administration’s decision, dismayed both foreign investors and India Inc. At this stage, it is unclear whether the AAP will be allowed to proceed with its withdrawal—the Commerce and Industry Ministry has rejected the AAP’s move, requesting an opinion from the Law Ministry on the issue. Though the uncertainty may come as a surprise to observers new to the scene, anyone who has followed the issue of FDI in multi-brand retail in India over the past several years could have anticipated this latest setback. 

A bumpy road to regulation
In November 2011, the Congress-led government decided to open up India’s retail sector to foreign direct investment for the first time. Previously, foreign multi-brand retailers could not invest directly in selling to consumers, though India did permit 100 percent FDI in cash and carry, or wholesale, outlets. 

The new policy included a host of stipulations. For example, foreign retailers had to bring in a minimum investment of $100 million, source at least 30 percent of their products from small and medium enterprises in India, and invest 50 percent of the total FDI amount in back-end infrastructure. Furthermore, retailers could only invest in cities with populations of over 1 million. The reforms, though lauded by foreign investors, were hotly contested in India. In December 2011, within 30 days of the announcement, the Congress Party bowed to pressure from the opposition and suspended the policy until political consensus was reached. 

Nearly a year later, in September 2012, the central government again ruled that FDI in multi-brand retail with up to 51 percent foreign ownership would be allowed. However, in an effort to win support for the policy a new stipulation was added—implementation of the new FDI policy would be left to the discretion of individual states.  This time, all states, even those without cities with a population of over 1 million, were permitted to allow FDI in multi-brand retail. 

Nine states and two union territories adopted the policy when it was introduced in September 2012. In 2013, two more states, Hinchal Pradesh and Karnataka, passed the policy after the Congress party came to power. 

The various stipulations created confusion and in June 2013, in response to questions from potential foreign investors, the central government issued clarifications on the retail policy that addressed several problematic issues, including sourcing and investment in infrastructure. The clarifications stipulated that the 30 percent local sourcing requirement would apply only to front end stores, and stock purchased for overseas operations would not count towards the requirement. The government also recalibrated the definition of small and medium enterprise and allowed foreign retailers to source from these SMEs even after crossing the threshold investment limit. On infrastructure, the clarifications mandated that the investment had be in greenfield—completely new—projects, rather than in brownfield—or existing—projects. 

Current state of the retail sector
Ever changing regulations have taken a toll on foreign investment in the sector. Though the Indian retail sector, now estimated to be worth more than $500 billion, grew quickly over the last decade, little of that growth stemmed from foreign investment. According to data released by the Department of Industrial Policy and Promotion, foreign investment in the retail sector from April 2000– September 2013 stood at only $97.29 million. 

To date, only one multinational retailer has made official plans to enter the Indian market. Tesco, the British retailer, secured approval in December 2013 for an initial investment of $110 million in Indian retailer Tata Group’s Trent Hypermarket.  It remains to be seen whether or not other retailers will follow Tesco’s lead.

Reactions to the AAP announcement
By withdrawing permission for FDI in multi-brand retail, the AAP fulfilled one of its campaign promises.  The party’s opposition to foreign investment in multi-brand retail stems from a desire to protect small “mom and pop” stores and the jobs they currently provide. AAP leader and current Chief Minister of Delhi Arvind Kejriwal was quoted as saying that foreign investment "leads to loss of jobs to a very large extent…There is huge unemployment in Delhi and AAP government does not wish to increase this unemployment. Delhi is not prepared for FDI."

Proponents of increased foreign investment in the retail sector argue that it will increase consumer choice and generate higher incomes for farmers while improving the country’s outdated supply chain infrastructure. Current supply chain logistics lead to increased wastage levels of 24-40 percent, with middlemen eating up a significant portion of the profits that could go to farmers. 

The AAP’s withdrawal highlights the precarious position of the sector under a state-by-state regulatory regime. By reversing the FDI policy of the prior administration, the AAP has fuelled concern among foreign investors that future state reversals might be applied retroactively, potentially exposing retailers to significant risk. Commerce and Industry Minister Anand Sharma highlighted this concern, saying, “States have the option to join. But it is not a revolving door. Policy has to have stability for investor confidence.” Furthermore, the lack of clarity from the center on whether state governments will be allowed to reverse the policy of previous administrations, exemplified by the Industry and Commerce Ministry’s reaction, only adds to the uncertainty.

Unfortunately for foreign investors, the AAP’s announcement could affect not only Delhi, but other states as well. According to PHD Chamber of Commerce President Sharad Jaipuria, "The Delhi government's decision is bound to impact the overall FDI scenario not just in Delhi but also associated states like Haryana, Rajasthan and Punjab because Delhi is the hub for northern states."

However, one emerging markets research group notes the AAP’s relative newness is a possible reason for optimism. “The danger with the AAP is not its obvious populist streak, but the risk that its…anti-corruption approach and its opposition to cronyism may end up as a reflexive anti-business stance…The good news for investors is that the AAP is really a work in progress and its future policy outlook has yet to take firm shape.”

The way forward    

If the AAP’s decision to withdraw permission for FDI in multi-brand retail in Delhi is allowed to stand, it will increase potential uncertainty for foreign retailers. Unfortunately, policy clarity at the national level is unlikely to come until after the national elections slated for spring 2014. 

The Bharatiya Janta Party (BJP), the main opposition party, is on record about its anti-FDI stance in multi-brand retail, but since winning the assembly elections in Rajasthan in December, it has not withdrawn approval for the policy in the state. Senior BJP leader and former External Affairs and Finance Minister Yashwant Sinha was quoted recently saying, “My advice to foreign multi-brand retailers is they should not hurry. India will face a general election in April-May. Before they (foreign companies) operationalise anything, they should wait for the new Government to clarify this policy.”

A fractured result in the national election in which no single party triumphs could lead to prolonged uncertainty. The best foreign investors can hope for is a clear winner, and policy clarity thereafter. In any scenario, Tesco’s recent application will be a key test case, potentially pointing the way forward for other retailers.