New opportunities and developments lie in store for foreign retailers
Feb. 2 – As India has liberalized its single brand retail industry to permit 100 percent foreign investment, we take a look at the regulatory issues and legal structures pertinent to establishing operations in this new dynamic market. That India should be well on the radar for foreign retailers was recently supported by A.T. Kearney, whose 2011 Global Retail Development Index ranks the nation as fourth globally.
India’s retail industry is estimated to be worth approximately US$411.28 billion and is still growing, expected to reach US$804.06 billion in 2015. As part of the economic liberalization process set in place by the Industrial Policy of 1991, the Indian government has opened the retail sector to FDI slowly through a series of steps:
The Indian government removed the 51 percent cap on FDI into single-brand retail outlets in December 2011, and opened the market fully to foreign investors by permitting 100 percent foreign investment in this area.
It has also made some, albeit limited, progress in allowing multi-brand retailing, which has so far been prohibited in India. At present, this is restricted to 49 percent foreign equity participation. The specter of large supermarket brands displacing traditional Indian mom-and-pop stores is a hot political issue in India, and the progress and development of the newly liberalized single-brand retail industry will be watched with some keen eyes as concerns further possible liberalization in the multi-brand sector.
In this article, we discuss the policy developments for FDI in these two retail categories, with a focus on the details of the multi-brand retail FDI discussion paper and related policy developments.
FDI in “single-brand” retail
While the precise meaning of single-brand retail has not been clearly defined in any Indian government circular or notification, single-brand retail generally refers to the selling of goods under a single brand name.
Up to 100 percent FDI is permissible in single-brand retail, subject to the Foreign Investment Promotion Board (FIPB) sanctions and conditions mentioned in Press Note 3. These conditions stipulate that:
- Only single-brand products are sold (i.e. sale of multi-brand goods is not allowed, even if produced by the same manufacturer)
- Products are sold under the same brand internationally
- Single-brand products include only those identified during manufacturing
- Any additional product categories to be sold under single-brand retail must first receive additional government approval
FDI in single-brand retail implies that a retail store with foreign investment can only sell one brand. For example, if Adidas were to obtain permission to retail its flagship brand in India, those retail outlets could only sell products under the Adidas brand. For Adidas to sell products under the Reebok brand, which it owns, separate government permission is required and (if permission is granted) Reebok products must then be sold in separate retail outlets.
FDI in “multi-brand” retail
While the government of India has also not clearly defined the term “multi-brand retail,” FDI in multi-brand retail generally refers to selling multiple brands under one roof. Currently, this sector is limited to a maximum of 49 percent foreign equity participation.
In July 2010, the Department of Industrial Policy and Promotion (DIPP) and the Ministry of Commerce circulated a discussion paper on allowing FDI in multi-brand retail. The Committee of Secretaries, led by Cabinet Secretary Ajit Seth, recommended opening the retail sector for FDI with a 51 percent cap on FDI, minimum investment of US$100 million and a mandatory 50 percent capital reinvestment into backend operations. Notably, the paper does not put forward any upper limit on FDI in multi-brand retail.
Immediately following the release of this discussion paper, the shares of a number of retail companies in India grew; domestic retail giant, Pantaloon Retail gained 7 percent on the same day, while Shoppers Stop, an Indian department store chain and emerging retailer, gained 2.9 percent.
The long-awaited scheme has been sent to the Cabinet for approval, but no decision has yet been made. There appears to be a broad consensus within the Committee of Secretaries that a 51 percent cap on FDI in multi-brand retail is acceptable. Meanwhile the Department of Consumer Affairs has supported the case for a 49 percent cap and the Small and Medium Enterprises Ministry has said the government should limit FDI in multi-brand retail to 18 percent. In terms of location, the proposed scheme allows investment in towns with populations of at least 10 lakh (1 million), while retailers with large space requirements may also be allowed to open shop within a 10 kilometer radius of such cities.
Our view is that while we do expect further liberalization towards foreign investment in the multi-brand sector, this is highly unlikely to be gazetted until after the next elections, due to be completed towards the end of 2012. Any additional liberalization of this market will therefore depend on the political make-up of the next government.
Government “safety valves” on FDI
There is concern about the competition presented to domestic competitors and the monopolization of the domestic market by large international retail giants. The Indian government feels that FDI in multi-brand retailing must be dealt with cautiously, given the large potential scale and social impact.
As such, the government is considering safety valves for calibrating FDI in the sector. For example:
- A stipulated percentage of FDI in the sector could be required to be spent on building back-end infrastructure, logistics or agro-processing units in order to ensure that the foreign investors make a genuine contribution to the development of infrastructure and logistics.
- At least 50 percent of the jobs in the retail outlet could be reserved for rural youth and a certain amount of farm produce could be required to be procured from poor farmers.
- A minimum percentage of manufactured products could be required to be sourced from the SME sector in India.
- To ensure that the public distribution system and the Indian food security system, is not weakened, the government may reserve the right to procure a certain amount of food grains.
- To protect the interest of small retailers, an exclusive regulatory framework to ensure that the retailing giants do not resort to predatory pricing or acquire monopolistic tendencies.
Benefits of FDI in multi-brand retail
Soaring inflation is one of the driving motives behind this move towards multi-brand retail. Allowing international retailers such as Wal-Mart and Carrefour, which have already set up wholesale operations in the country, to set up multi-brand retails stores will assist in keeping food and commodity prices under control. Moreover, industry experts feel allowing FDI will cut waste, as big players will build backend infrastructure. FDI in multi-brand retail would also help narrow the current account deficit.
Additional benefits include moving away from an industry focus on intermediaries and job creation.
Moving away from intermediary-only benefits
There is broad agreement on the need to improve efficiencies in the household trade of consumer goods. Competent management practices and economies of scale, joined with the acceptance of global best practices and modern technology, could immensely recover systemic competence.
Like their foreign counterparts, Indian customers are entitled to receive quality products, produced, processed and handled under a hygienic environment through professionally-managed outlets. Speculative apprehensions that small retailers will be adversely affected are not reason enough to deny millions of consumers access to products that meet global standards.
Furthermore, today’s intermediaries amid producers and customers add no value to the products, adding hugely to final costs instead. By the time products filter through various intermediaries and into the marketplace, they lose freshness and quality, and often go to waste. However, intermediaries garner huge profits by distributing these losses between producers and customers by buying products at low prices from producers, but selling at extremely marked-up prices to consumers. In an unbalanced system that incorporates multiple intermediaries simply for logistics, only intermediaries benefit.
With organized retail, every intermediate step – procurement, processing, transport and delivery – adds value to the product. This happens because it uses international best practices and modern technology, ensuring maximum efficiency and minimum waste. Organized retail enables on-site processing, scientific handling and quick transport through cold storage chains to the final consumer. Once modern retailers introduce an organized model, other vendors, including small retailers, would mechanically copy this model to improve efficiencies, boost margins and stay in business. Organized retail would thereby bring more stability to prices, unlike the present system where hoarding and artificial shortages by profiteering intermediaries push up product prices.
Despite predictions from some analysts that millions of jobs would be lost due to FDI in retail, it may in fact be the other way around. With the entry of branded retailers, the market will increase, creating additional employment in retail and other tertiary sectors. Given their professional approach, organized retailers will allot some quantity of resources towards the training and development of the resources they employ.
This effect of branded retailing can already be seen with the Bharti-Wal-Mart collaboration, which has joined forces with state governments to open training and development centers in Amritsar, Delhi and Bangalore, preparing local youth for jobs in retail. Training is entirely free and more than 5,600 local youth have already been trained. Retail jobs don’t require higher education or highly specialized abilities.
No threat to kiranas (mom-and-pop stores)
The Indian retail industry is generally divided into organized and unorganized retailing:
Organized retailing refers to trading activities undertaken by licensed retailers, those who have registered for sales tax, income tax, etc. These include corporate-backed hypermarkets and retail chains, and also privately-owned large retail businesses.
Unorganized retailing refers to the traditional forms of low-cost retailing, for example, local kirana shops, owner-operated general stores, paan/beedi shops, convenience stores, hand cart and street vendors, etc.
The question of whether or not organized and unorganized retailing can peacefully co-exist is a primary concern. While the Indian retail sector is still heavily weighted towards unorganized retailers, which occupy 97 percent of the market, organized retail is growing quickly. But with a mere 7 percent of the market, organized retailers are unlikely to drive kiranas (local grocery stores) out of business. Indian retailers simply lack the deep pockets and in-depth field expertise required to be on a par with global models. However, the presence of foreign retailers through joint ventures and other means could speed up the process of transforming India’s retail trade. Considering that small stores offer customers quick doorstep delivery and even credit extensions – conveniences that no organized retailer in India has so far matched – local, unorganized retailers will likely retain a sizeable market share.
The example of China demonstrates clearly that increased FDI in retailing does not necessitate the complete closure of local retailers. China first allowed FDI in retail in 1992, capping it at 26 percent, while India capped FDI in single-brand retail at 26 percent. Only in 2004 did China finally permit 100 percent FDI and local Chinese grocery stores have since grown from 1.9 million to more than 2.5 million. Organized retail has just 20 percent market penetration in China, despite a 20 year lapse since the initial introduction of FDI.
According to the proposed state regulations, the minimum FDI would be US$100 million and retail stores would only be allowed in cities with more than one million people. Front-end operations would be allowed only in states that agree to authorize FDI in multi-brand retail. It will also be mandatory for retailers to source at least 30 percent of the value of manufactured goods, barring food products, from small and medium-sized, local enterprises.
Such terms will serve as ample safeguards for small retailers. Farmers and small producers will benefit in the long run from better prices for their products and produce, while consumers receive higher quality products at lower prices, along with better service.
The advantages outweigh the disadvantages of allowing unrestrained FDI in the retail sector, as successful experiments in countries like Thailand and China demonstrate. In both countries, the issue of allowing FDI in the retail sector was first met with incessant protests, but allowing such FDI led to GDP growth and a rise in the level of employment.
Moreover, in the fierce battle between the advocates and opponents of unrestrained FDI flows in the Indian retail sector, the impact of the consumer on the outcome of these policy changes has been largely disregarded. Consumers will ultimately respond to the incentives of convenience, price, variety and service. Thus, the interests of those in the unorganized retail sector will not be gravely undermined; rather, the choice to visit a mega shopping complex or a small retailer/sabjimandi is purely left to the consumer, whose tastes are complex and constantly changing.
Chris Devonshire-Ellis is the founding partner and principal of Dezan Shira & Associates, a specialist foreign direct investment firm with 20 offices throughout Asia, including 5 in India. The practice advices on foreign direct investment regulatory issues, law, tax, due diligence and business advisory services. Please contact the firm at email@example.com or visit their web site here.
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