(Article) CSM - November 2012: FDI in Retail: Back to Economic Reform

FDI in Retail Back to Economic Reform

Henry Ford, the genius inventor once famous said, “Don’t find fault, find a remedy” . This adage reverberates ever so relevantly in today’s Indian retail sector scenario like never before. India, over the latter half of the previous decade, has been one of the most sought after destinations for investors across the globe. The retail sector in particular has been one of the sectors where there has been a constant buzz and excitement surrounding government policy shaping the sector. Though the voices have been growing louder for Multi-Brand FDI to be permitted for retail, there is still a long way to go before all the pieces of the jigsaw are put together. For the moment though, the Indian government aims to take up this case gradually as suggested by the 2010-11 Economic Survey report which states “Permitting FDI (foreign direct investment) in retail in a phased manner beginning with metros and incentivizing the existing retail shops to modernize could help address the concerns of farmers and consumers. FDI in retail may also help bring in technical know-how to set up efficient supply chains which could act as models of development.”

There are a multitude of reasons being floated around to prevent the liberalisation of the FDI norms for Indian retail:

  • Primary among these is the concern regarding the kirana stores as well other locally operated Mom and Pop stores being adversely affected by the entry of global retail giants such as Walmart, Carrefour and Tesco. As these brands would come with advanced capabilities of scale and infrastructure in addition to having deep pockets, it is argued that this would result in the loss of jobs for lakhs of people absorbed in the unorganised sector.

  • There has also been a debate over the kind of employment that would be generated as it is assumed that semi-skilled people would not be absorbed into the system. As majority of the workforce in India falls in this category, doubts have been parlayed about the value that would be generated by opening up the sector.

  • Fears have also been raised over the lowering of prices of products owing to better operational efficiencies of the organised players that would affect the profit margins of the unorganised players.
  • Instability surrounding the political arena with a number of scams of varying magnitudes doing the rounds has also led to a sense of uncertainty among foreign investors.

The Indian retail sector has predominantly comprised of unorganised players in the form of locally owned, Mom and Pop stores or the ‘kirana’ stores as they are known in common parlance, single owner general stores, paanshops, convenience stores, hand cart and pavement vendors, etc. On the other hand, organised retailing involves trading activities undertaken by licensed retailers, that is, those who are registered for sales tax, income tax, etc. basically involving the corporate-backed hypermarkets and retail chains, and also the privately owned large retail businesses.

However, the tremendous growth prospect of the sector coupled with successfully established models of organised retail in other Asian markets such as China has paved the way for the establishment of organised retail in India as well. In addition to this, a number of home-grown corporate giants such as Future Group and Aditya Birla retail have furthered the cause of organised retail by setting up exclusive outlets across India. Nevertheless, there is still a long way to go before Foreign Direct Investment (FDI) in Indian Retail can be realised in its entirety.

The Indian retail is a robust pillar of the economy with a 13% contribution to the GDP and employs 6% of the nation’s workforce. According to India Brand Equity Foundation (IBEF), the Indian retail is valued at about US$ 450 billion, expected to grow by 10.2% in 2011- 12. Of this, organised retail onlyforms 6.5% of the pie. Hence, there is enormous scope for expansion through infrastructure and investment support. Furthermore, while unorganised retail has been pegged at a rate of 6% annually, organised retail has been booming at a stupendous growth rate of 35%. In fact, it is expected to reach 16-18% of the total market within the next five years.

A recent A.T.Kearney annual Global Retail Development Index (GRDI) confirmed India as the most attractive market for retail investment for a third consecutive year. Despite this, the entry for global retail giants in the form of FDI’s has remained more or less restricted and the government has maintained a tight leash over the FDI policy in retail, primarily owing to perceived threat posed by organised retailers on the small scale kiranashop owners. At present, India’s FDI policy in retail provides for the following guidelines, as issued by the Department of Industrial Policy and Promotion (DIPP):

  • FDI up to 100% is allowed for cash and carry wholesale trading and export trading under the automatic route.
  • FDI up to 51% with prior Government approval (FIPB route) for retail trade of Single Brand products, permitted from 2006 onwards.
  • FDI is not permitted for multibrand retail in India.

The term “Single Brand” has not been specifically defined by the government anywhere although the press note 3 released by DIPP in 2006 provides a few guidelines:

  1. Only single brand products would be sold (i.e., retail of goods of multi-brand even if produced by the same manufacturer would not be allowed)
  2. Products should be sold under the same brand internationally
  3. Single-brand product retail would only cover products which are branded during manufacturing
  4. Any addition to product categories to be sold under “single-brand” would require fresh approval from the government.

Despite these guidelines, there has been plenty of ambiguity regarding the classification of single brands in case of sub-brands and cobranded products and consequently, whether or not these would come under the ambit of the FDI norm of 51% FDI for “Single” brands.

The major provisions for FDI investment include that the minimum investment will have to be $100 million. Retail stores will only be allowed in cities with more than one million people. Also it will be mandatory for retailers to source a minimum 30 per cent of the value of manufactured goods, barring food products, from small and medium enterprises. Investment up to 50 per cent will have to be in storage and back-end infrastructure. India being a signatory to World Trade Organisation’s General Agreement on Trade in Services, which include wholesale and retailing services, had to open up the retail trade sector to foreign investment. There were initial reservations towards opening up of retail sector arising from fear of job losses, procurement from international market, competition and loss of entrepreneurial opportunities. FDI in cash and carry or wholesale trade, was allowed way back in 1997 during the United Front Government. Foreign investment of up to 51 per cent in single brand retailing came to India in January 2006.

The Union government further asserted that 30 per cent sourcing under FDI in multi-brand retail has been made mandatory from Indian MSEs only. The government highlighted that the 30 per cent obligation before the global players is limited to India. The government’s explanation came amidst protests from the opposition and the micro and small enterprises (MSEs). According to government’s previous stand, the overseas players have to do 30 per cent of their sourcing from  MSEs which, however, can be done from anywhere in the world and is not India-specific. The only condition placed was that these MSEs must not have more than $1 million [Rs.5 crore] investment in plant and machinery.

In 2004, The High Court of Delhi defined the term ‘retail’ as a sale for final consumption in contrast to a sale for further sale or processing (i.e. wholesale), A sale to the ultimate consumer. Thus, retailing can be said to be the interface between the producer and the individual consumer buying for personal consumption. This excludes direct interface between the manufacturer and institutional buyers such as the government and other bulk customers Retailing is the last link that connects the individual consumer with the manufacturing and distribution chain. A retailer is involved in the act of selling goods to the individual consumer at a margin of profit.

Many Industry experts though, feel that the reservations against the introduction of Multi-Brand retail are mostly misplaced. The successful deployment of 100%FDI in China is a case in point. Partial FDI in retail was introduced in 1992 in China. Subsequently, in December 2004, the Chinese retail market was fully opened up to utilise the enormous manpower and wide customer base available that has led to a rapid growth of the sector. Today, its retail sector is the second largest (in value) in the world with global retailers such as Walmart, 7-Eleven and Carrefour comprising 10% of the total merchandise.

Multi-brand retail, if allowed, is expected to transform the retail landscape in a significant way:

  • Firstly, the organised players would bring in the much needed investment that would spur the further growth of the sector. This would be particularly important for sustenance of some of the domestic retailers that don’t have the resources to ride out the storm during an economic slump such as the case with Vishal, Subhikshaand Koutons, which couldn’t arrange for funds to sustain their growth.

  • The technical know-how, global best practices, quality standards and cost competitiveness brought forth through FDI would augur well for the domestic players to garner the necessary support to sustain their growth.

  • Indian has also been crippled by rising inflation rates that have refused to come within accepted levels. A key reason for this has been attributed to the vastly avoidable supply chain costs in the Indian food and grocery sales which has been estimated to be a whopping US$ 24 Bn. The infrastructure support extended to improve the backend processes of the supply chain would enable to eliminate such wastages and enhance the operational efficiency.

  • FDI in multi-brand retail would in no way endanger the jobs of people employed in the unorganised retail sector. On the contrary, it would lead to the creation of millions of jobs as massive infrastructure capabilities would be needed to cater to the changing lifestyle needs of the urban Indian who is keen on allocating the disposable income towards organised retailing in addition to the local kirana stores. Thesestores would be able to retain their importance owing to their unique characteristics of convenience, proximity and skills in retaining customers. Also, these would be more prominent in the Tier-II and Tier-III cities where the organised supermarkets would find it harder to establish themselves.

  • The numerous intermediaries would be restricted and therefore, the farmers would get to enjoy a bigger share of the pie.

FDI in multi-brand retail is therefore a necessary step that needs to be taken to propel further growth in the sector. This would not only prove to be fruitful for the economy as a whole but will also integrate the Indian retail sector with the global retail market.It is not a question of ‘how’ it will be done but ‘when’. The retail industry is mainly divided into:- 1) Organised and 2) Unorganised Retailing Organised retailing refers to trading activities undertaken by licensed retailers, that is, those who are registered for sales tax, income tax, etc. These include the corporate-backed hypermarkets and retail chains, and also the privately owned large retail businesses. Unorganised retailing, on the other hand, refers to the traditional formats of low-cost retailing, for example, the local kirana shops, owner manned general stores, paan/beedi shops, convenience stores, hand cart and pavement vendors, etc. The Indian retail sector is highly fragmented with 97 per cent of its business being run by the unorganized retailers. The organized retail however is at a very nascent stage. The sector is the largest source of employment after agriculture, and  has deep penetration into rural India generating more than 10 per cent of India’s GDP.

For those brands which adopt the franchising route as a matter of policy, the current FDI Policy will not make any difference. They would have preferred that the Government liberalize rules for maximizing their royalty and franchise fees. They must still rely on innovative structuring of franchise arrangements to maximize their returns. Consumer durable majors such as LG and Samsung, which have exclusive franchisee owned stores, are unlikely to shift from the preferred route right away. For those companies which choose to adopt the route of 51% partnership, they must tie up with a local partner. The key is finding a partner which is reliable and who can also teach a trick or two about the domestic market and the Indian consumer.

Positive aspects

FDI can be a powerful catalyst to spur competition in the retail industry, due to the current scenario of low competition and poor productivity. The policy of singlebrand retail was adopted to allow Indian consumers access to foreign brands. Since Indians spend a lot of money shopping abroad, this policy enables them to spend the same money on the same goods in India. FDI in single-brand retailing was permitted in 2006, up to 51 per cent of ownership. Between then and May 2010, a total of 94 proposals have been received. Of these, 57 proposals have been approved. An FDI inflow of US$196.46 million under the category of single brand retailing was received between April 2006 and September 2010, comprising 0.16 per cent of the total FDI inflows during the period. Retail stocks rose by as much as 5%. Shares of Pantaloon Retail (India) Ltd ended 4.84% up at Rs 441 on the Bombay Stock Exchange. Shares of Shopper’s Stop Ltd rose 2.02% and Trent Ltd, 3.19%. The exchange’s key index rose 173.04 points, or 0.99%, to 17,614.48. But this is very less as compared to what it would have been had FDI up to 100% been allowed in India for single brand. The policy of allowing 100% FDI in single brand retail can benefit both the foreign retailer and the Indian partner – foreign players get local market knowledge, while Indian companies can access global best management practices, designs and technological knowhow. By partially opening this sector, the government was able to reduce the pressure from its trading partners in bilateral/ multilateral negotiations and could demonstrate India’s intentions in liberalising this sector in a phased manner.

FDI in retail is not a simple exercise to be covered in a single article but an in-depth study will take quite sometime and its impact cannot be visualized easily. If Reliance and Big Bazaar have come to stay, so will the FDI in retail, in due course. FDI in retail will be subject to a lot of discussions and scrutiny. To generalize and compare how other countries have fared and still let kirana (small shops in road corners) survive or bring about better returns to farmer is a futile exercise. The conditions in India are different. We need to clearly spell out some basic preconditions that have to be complied within a specified time-frame, failing which, the licensee will have to pack up and go home.

  1. At least 30% of the indigenous farm produce will have to be retailed
  2. Each FDI-R licensee be given the choice of seven to 10 locations where it can commence its actual retail operations
  3. These operating centres will have to be supported by actual infrastructural development of warehouses, cold storage and transportation logistics in identified sources of supply at the produce points
  4. The next set of new cities will be after successful performance, a minimum of 18- 24 months later, with the same conditions relating to infrastructure development or by expansion of existing ones
  5. The activities of the FDI-R licensee will be subject to a close check and follow-up by a regulator who will maintain a watchdog committee for keeping a track of purchase pricing to retail selling; of the actual commitments in terms of fulfilling employment growth and how these actually are benefiting the country in terms of taxes earned
  6. These FDI-R licensees should not become the single largest selling point for marketing products of other countries when identical or similar products of indigenous makes are readily available.

These measures would be the first of many that one can think of as a start.

Permitting foreign investment in food-based retailing is likely to ensure adequate flow of capital into the country & its productive use, in a manner likely to promote the welfare of all sections of society, particularly farmers and consumers. It would also help bring about improvements in farmer income & agricultural growth and assist in lowering consumer prices inflation. Apart from this, by allowing FDI in retail trade, India will significantly flourish in terms of quality standards and consumer expectations, since the inflow of FDI in retail sector is bound to pull up the quality standards and costcompetitiveness of Indian producers in all the segments. It is therefore obvious that we should not only permit but encourage FDI in retail trade. Lastly, it is to be noted that the Indian Council of Research in International Economic Relations (ICRIER), a premier economic think tank of the country, which was appointed to look into the impact of BIG capital in the retail sector, has projected the worth of Indian retail sector to reach $496 billion by 2011- 12 and ICRIER has also come to conclusion that investment of ‘big’ money (large corporates and FDI) in the retail sector would in the long run not harm interests of small, traditional, retailers. In light of the above, it can be safely concluded that allowing healthy FDI in the retail sector would not only lead to a substantial surge in the country’s GDP and overall economic development, but would inter alia also help in integrating the Indian retail market with that of the global retail market in addition to providing not just employment but a better paying employment, which the unorganized sector (kirana and other small time retailing shops) have undoubtedly failed to provide to the masses employed in them.

Concerns

It is feared that, it would lead to unfair competition and ultimately result in large-scale exit of domestic retailers, especially the small family managed outlets, leading to large scale displacement of persons employed in the retail sector. Further, as the manufacturing sector has not been growing fast enough, the persons displaced from the retail sector would not be absorbed there. Another concern is that the Indian retail sector, particularly organized retail, is still under-developed and in a nascent stage and that, therefore, it is important that the domestic retail sector is allowed to grow and consolidate first, before opening this sector to foreign investors. Antagonists of FDI in retail sector oppose the same on various grounds, like, that the entry of large global retailers such as Wal-Mart would kill local shops and millions of jobs, since the unorganized retail sector employs an enormous percentage of Indian population after the agriculture sector; secondly that the global retailers would conspire and exercise monopolistic power to raise prices and monopolistic (big buying) power to reduce the prices received by the suppliers; thirdly, it would lead to asymmetrical growth in cities, causing discontent and social tension elsewhere. Hence, both the consumers and the suppliers would lose, while the profit margins of such retail chains would go up.

Argument that only foreign players can create the supply chain for farm produce is bogus. International retail players have no role in building roads or generating power. They are only required to create storage facilities and cold chains. This could be done by governments in India. Move will lead to large-scale job losses. International experience shows supermarkets invariably displace small retailers. Small retail has virtually been wiped out in developed countries like the US and in Europe. South East Asian countries had to impose stringent zoning and licensing regulations to restrict growth of supermarkets after small retailers were getting displaced. Fragmented markets give larger options to consumers. Consolidated markets make the consumer captive. Allowing foreign players with deep pockets leads to consolidation. International retail does not create additional markets, it merely displaces existing markets. India has the highest shopping density in the world with 11 shops per 1,000 people. It has 1.2 crore shops employing over 4 crore people; 95% of these are small shops run by selfemployed people. Global retail giants will resort to predatory pricing to create monopoly/oligopoly. This can result in essentials, including food supplies, being controlled by foreign organizations. Jobs in the manufacturing sector will be lost because structured international retail makes purchases internationally and not from domestic sources. This has been the experience of most countries which have allowed FDI in retail. Comparison between India and China is misplaced. China is predominantly a manufacturing economy. It’s the largest supplier to Wal-Mart and other international majors. It obviously cannot say no to these chains opening stores in China when it is a global supplier to them. India in contrast will lose both manufacturing and services jobs.

Conclusion

Conclusively we can say that FDI in retail has the both positive as well as negative aspects of it, but what we should consider before jumping on any conclusion that fears of small shopkeepers getting displaced are vastly exaggerated. When domestic majors were allowed to invest in retail, both supermarket chains and neighbourhood pop-and-mom stores coexisted. India Inc hailed the government’s decision to implement FDI in multi brand retail and voiced that it will give a strong message to investors that the government means business and stands firm on its initiatives. This decision is a right step and will go a long way in capital infusion and is expected to strengthen the farmer’s community. If anything, the entry of retail big boys is likely to hot up competition, giving consumers a better deal, both in prices and choices. Mega retail chains need to keep price points low and attractive - that’s the USP of their business. This is done by smart procurement and inventory management: Good practices from which Indian retail can also learn. The argument that farmers will suffer once global retail has developed a virtual monopoly is also weak. To begin with, it’s very unlikely that global retail will ever become monopolies. Stores like Wal-Mart or Tesco are by definition few, on the outskirts of cities (to keep real estate costs low), and can’t intrude into the territory of local kiranas. So, they cannot eat up their share of pie. Secondly, it can’t be anyone’s case that farmers are getting a good deal right now. The fact is that farmers barely subsist while middlemen take the cream. Let’s not get dreamy about this unequal relationship.

Sandeep Dogra

 

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