Foreign Direct Investment in the retail industry of India

The Indian retail industry is divided into institutionalized and uninstitutionalized sectors. Institutionalized 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. Uninstitutionalized retailing while 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.

India’s retail sector is wearing new clothes and with a three-year compounded annual growth rate of 46.64 per cent, retail is the fastest growing sector in the Indian economy. Traditional markets are also wearing new clothes, coming-up with formats like departmental stores, hypermarkets, supermarkets and specialty stores. Western-style malls have begun appearing in metros and second-rung cities alike, introducing the Indian consumer to an unparalleled shopping experience.

The Indian retail sector is fragmented with 97 per cent of its business being run by the uninstitutionalized retailers. The traditional family runs stores and corner stores. The institutionalized retail however is at a very nascent stage though attempts are being made to increase its proportion to 9-10 per cent and bring a huge opportunity for prospective new players. 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.

Large Indian players like Reliance, Ambanis, K Rahejas, Bharti AirTel, ITC and many others are making significant investments in this sector leading to emergence of big retailers who can bargain with suppliers to reap benefits of economies of scale. Hence, discounting is becoming an accepted practice. Proper infrastructure is the need of an hour in retailing, which would help to modernize India and facilitate rapid economic growth. This would help in efficient delivery of goods and value-added services to the consumer making a higher contribution to the GDP.

International retailers see India as the last retailing frontier left as the China’s retail sector is saturated by now. However, the Indian Government restrictions on the FDI are creating ripples among the international players like Walmart, Tesco and many other retail giants struggling to enter Indian markets. As of now the Government has allowed only 51 per cent FDI in the sector to ‘one-brand’ shops like Nike, Reebok etc. However, other international players are taking alternative options available to them to enter in the Indian retail market indirectly via strategic licensing agreement, franchisee agreement and cash and carry wholesale trading (since 100 per cent FDI is allowed in wholesale trading).

Furthermore, according to a report titled ‘India Institutionalized Retail Market 2010’, published by Knight Frank India in May 2010 during 2010-12, around 55 million square feet (sq ft) of retail space will be ready in Mumbai, national capital region (NCR), Bengaluru, Chennai, Hyderabad and many other metros of the country. Besides, between 2010 and 2012, the institutionalized retail real estate stock will grow from the existing 41 million sq ft to 95 million sq ft.

FDI in India:

The Government’s liberalization and economic reforms programme aims at rapid and substantial economic growth, and integration with the global economy in a harmonized manner. The industrial policy reforms have reduced the industrial licensing requirements, removed restrictions on investment and expansion, and facilitated easy access to foreign technology and foreign direct investment.

Foreign Direct Investment (FDI) is now realized as an important driver of growth in the country. Government is, therefore, making all efforts to attract and facilitate FDI and investment from Non Resident (NRIs) including Overseas Corporate Bodies (OCBs) that are predominantly owned by them, to complement and supplement domestic investment. To make investment in India attractive, investment and returns on them are freely repatriable, except where the approval is subject to specific conditions such as lock -in period on original investment, dividend cap, foreign exchange neutrality, etc. as per the notified sectoral policy. The condition of dividend balancing that was applicable to FDI in 22 specified consumer goods industries stands withdrawn for dividends declared after 14th July 2000, the date on which Press Note No. 7 of 2000 series was issued.

Foreign direct investment is freely allowed in all sectors including the services sector, except a few sectors where the existing and notified sectoral policy does not permit FDI beyond a ceiling. FDI for virtually all items/activities can be brought in through the Automatic Route under powers delegated to the Reserve Bank of India (RBI), and for the remaining items/activities through Government approval. Government approvals are accorded on the recommendation of the Foreign Investment Promotion Board (FIPB).

For the following categories, Government approval for FDI/NRI/OCB through the FIPB shall be necessary: –

(i) All proposals that require an Industrial Licence which includes (1) the item requiring an

Industrial Licence under the Industries (Development & Regulation) Act, 1951; (2) foreign investment being more than 24 per cent in the equity capital of units manufacturing items reserved for small scale industries; and (3) all items which require an Industrial Licence in terms of the locational policy notified by Government under the New Industrial Policy of 1991.

(ii) All proposals in which the foreign collaborator has a previous venture/tie up in India. The modalities prescribed in Press Note No. 18 dated 14.12.1998 of 1998 Series, shall apply to such cases. However, this shall not apply to investment made by multilateral financial institutions such as ADB, IFC, CDC, DEG, etc. as also investment made in IT sector.

(iii) All proposals relating to acquisition of shares in an existing Indian company in favour of a foreign/NRI/OCB investor.

(iv) All proposals falling outside notified sectoral policy/caps or under sectors in which FDI is not permitted.

Areas/sectors/activities hitherto not open to FDI/NRI/OCB investment shall continue to be so unless otherwise decided and notified by Government.

Current Status:

India’s retail industry accounts for 10 percent of its GDP and 8 percent of the employment to reach $17 billion by 2010.

The Indian retail market is estimated at US$ 350 billion. But institutionalized retail is estimated at only US$ 8 billion. However, the opportunity is huge-by 2010, institutionalized retail is expected to grow at 6 per cent by 2010 and touch a retail business of $ 17 billion as against its current growth level of 3 per cent which at present is estimated to be $ 6 billion, according to the Study undertaken by The Associated Chambers of Commerce and Industry of India (ASSOCHAM). Indian retailing is clearly at a tipping point. India is currently the ninth largest retail market in the world. And it is names of small towns like Dehradun, Vijayawada, Lucknow and Nasik that will power India up the rankings soon.

Institutionalized retail in India has the potential to add over Rs. 2,000 billion (US$45 billion) business by the Year 2010 generating employment for some 2.5 million people in various retail operations and over 10 million additional workforces in retail support activities including contract production & processing, supply chain & logistics, retail real estate development & management etc. It is estimated that it will cross the $650-billion mark by 2011, with an already estimated investment of around $421 billion slated for the next four years.

FDI in Multi-Brand retailing is prohibited in India. FDI in Single-Brand Retailing was, however, permitted in 2006, to the extent of 51%. Since then, a total of 94 proposals have been received till May, 2010. Of this, 57 proposals were approved. An FDI inflow of US $ 194.69 million (Rs. 901.64 crore) was received between April, 2006 and March, 2010, comprising 0.21% of the total FDI inflows during the period, under the category of single brand retailing. The proposals received and approved related to retail trading of sportswear, luxury goods, apparel, fashion clothing, jewellery, hand bags, life-style products etc., covering high-end items. Single brand retail outlets with FDI generally pertain to high-end products and cater to the needs of a brand conscious segment of the population, mainly attracting a brand loyal clientele, which often has a pre-set positive disposition towards the specific brand. This segment of customers is distinctly different from one that is catered by the small retailers/ kirana shops.

Problems:

There has been a lack of investment in the logistics of the retail chain, leading to an inefficient market mechanism. Though India is the second largest producer of fruits and vegetables (about 180 million MT), it has a very limited integrated cold-chain infrastructure, with only 5386 stand-alone cold storages, having a total capacity of 23.6 million MT. , 80% of this is used only for potatoes. The chain is highly fragmented and hence, perishable horticultural commodities find it difficult to link to distant markets, including overseas markets, round the year. Storage infrastructure is necessary for carrying over the agricultural produce from production periods to the rest of the year and to prevent distress sales. Lack of adequate storage facilities cause heavy losses to farmers in terms of wastage in quality and quantity of produce in general, and of fruits and vegetables in particular. Post-harvest losses of farm produce, especially of fruits, vegetables and other perishables, have been estimated to be over Rs. 1 trillion per annum, 57 per cent of which is due to avoidable wastage and the rest due to avoidable costs of storage and commissions [1] . As per some industry estimates, 25-30% of fruits and vegetables and 5-7% of food grains in India are wasted [2] . Though FDI is permitted in cold-chain to the extent of 100%, through the automatic route, in the absence of FDI in retailing; FDI flow to the sector has not been significant.

Intermediaries dominate the value chain. They often flout mandi norms and their pricing lacks transparency. Wholesale regulated markets, governed by State APMC Acts, have developed a monopolistic and non-transparent character. According to some reports, Indian farmers realize only 1/3rd of the total price paid by the final consumer, as against 2/3rd by farmers in nations with a higher share of institutionalized retail [3] . A study commissioned by the World Bank attributes the export non-competitiveness of India’s horticulture produce to its weak supply chain. The study shows that the average price that the farmer receives for a typical horticulture product is only 12-15 per cent of the price the consumer pays at a retail outlet [4] .

There is a big question mark on the efficacy of the public procurement and PDS set-up and the bill on food subsidies is rising. In spite of such heavy subsidies, overall food based inflation has been a matter of great concern. The absence of a ‘farm-to-fork’ retail supply system has led to the ultimate customers paying a premium for shortages and a charge for wastages.

The MSME sector has also suffered due to lack of branding and lack of avenues to reach out to the vast world markets. While India has continued to provide emphasis on the development of MSME sector, the share of uninstitutionalized sector in overall manufacturing has declined from 34.5% in 1999-2000 to 30.3% in 2007-08 [5] . This has largely been due to the inability of this sector to access latest technology and improve its marketing interface.

Entry of foreign players must be gradual with social safeguards so that the effects of labour dislocation can be analysed and policy fine tuned. Foreign players should initially be allowed only in metros.

The CPAS study also argued that the two facts, i.e. that the uninstitutionalized retail sector of small and medium retailers employs over 40 million; and that we have 11 retail outlets for every 1000 people5, suggests a considerable element of ‘forced employment’ in this sector. The reality of jobless growth only adds to the ‘forced employment’. Mind you only 4% of India’s 11 million retail outlets have floor areas in excess of 500 sq.ft6. This should dispel any image of any preponderance of large-scale retailing we may have derived to the size of the old established downtown retail outlets and in the new suburban malls. Retail in India is mostly the millions of tiny shops with pucca and semi-pucca premises, and millions more on handcarts and pavements. Hence the CPAS study argued that entry of large format mass retailers like Wal-Mart is fraught with many risks.

The National Sample Survey relating to household expenditures as evidenced by Table 6 are revealing. Fruits and vegetables only account for 9.88% of urban household expenditure9. It is widely agreed that the supply chain that links the Indian producer to the domestic consumer is primitive, outmoded and wasteful. Many studies exist that detail the extent of wastage. We will readily concede that large format retailing with its capacity for bulk procurement and capital investment, even if it accounts for a fraction of the retail trade in the sector, might be able to make some headway in modernizing the supply chain. But this does not make FDI imperative.

This experience should open the eyes of those who argue that our farmers will gain preferential entry into international markets by the likes of Wal- Mart. In case the coffee experience is not convincing lets consider other such experiences. The cocoa farmers of Ghana now receive only 3.9% of the price of a typical milk chocolate bar but the retail margin hovers around 34.1%. A banana farmer in South America gets 5% of the retail price of the banana while 34% accrues to distribution and retail. For value added clothing items such as jeans, no less than 54% of the final price goes to the retailers, while the manufacturing labor gets around 12%19. Apart from the disadvantageous terms of trade for producers in developing countries, the situation is worsening steadily for primary products everywhere vis-à-vis the concentrated bargaining powers of the multinational retail giants.

The MNC’s will deal with only the large-growers, fix prices in advance and the system of transparent auctions in Mandis will be bypassed. Since no two supermarket chains will operate in the same domain, farmers will have no choice but to comply with the lower prices offered by the retailer. The supermarket will earn premiums from customers for improved quality; the rejects will be dumped on the local farmers lowering their earnings. Our farm sector is in a deep crisis as it is, and we should not invite any more trouble.

Manufacturing sector in India must be developed to address the dislocation of existing retailers.

Prospects:

It is estimated that India will need substantial investment to develop infrastructure for supporting retail development. A significant portion of this will need to be earmarked for up gradation of the supply chain for fruits & vegetables. A major portion of his investment is expected to come from the private sector, for which an appropriate regulatory and policy environment is necessary.

FDI’s potential for impact can be greater because of the combination of scale, capital, and global capabilities which allow MNCs to close existing large productivity gaps more aggressively.

FDI can be a powerful catalyst to spur competition in industries characterized by low competition and poor productivity. Examples include the cases of consumer electronics in Brazil and India, food retail in Mexico, and auto in China, India, and Brazil.

Increasingly, foreign direct investment is integrating developing countries into the global economy, creating large economic benefits to both the global economy and to the developing countries themselves. Industry restructuring enables global growth as companies reduce production costs and create new markets. For the large developing countries, integrating into the global economy through foreign direct investments improves standards of living by improving productivity and creating output growth. The biggest beneficiaries from this transition are consumers – both global consumers that reap the benefits from global industry restructuring, and consumers in the host countries that see their purchasing power and standards of living improve.

In the initial stage, FDI up to 49% could be allowed to enable domestic players to enter into joint ventures have access to investment, technological know-how and best management practices while retaining management control.

The 2008 study has observed that institutionalized retail, which now constitutes a small four per cent of the total retail sector, is likely to grow at a much faster pace of 45-50 per cent per annum and quadruple its share in total retail trade to 16 per cent by 2011-12. However, this represents a positive sum game in which both uninstitutionalized and institutionalized retail not only coexist but also grow substantially in size.

The BMI India Retail Report for the third-quarter of 2010, forecasts that the total retail sales will grow from US$ 353 billion in 2010 to US$ 543.2 billion by 2014. With the expanding middle and upper class consumer base, there will also be opportunities in India’s tier II and III cities. The greater availability of personal credit and a growing vehicle population to improve mobility also contribute to a trend towards annual retail sales growth of 11.4 per cent. Mass grocery retail (MGR) sales in India are forecast to undergo enormous growth over the forecast period. BMI further predicts that sales through MGR outlets will increase by 154 per cent to reach US$ 15.29 billion by 2014. This is a consequence of India’s dramatic, rapid shift from small independent retailers to large, modern outlets.

Moreover, for the 4th time in five years, India has been ranked as the most attractive nation for retail investment among 30 emerging markets by the US-based global management consulting firm, A T Kearney in its 8th annual Global Retail Development Index (GRDI) 2009. India remains among the leaders in the 2010 GRDI and presents major retail opportunities. India’s retail market is expected to be worth about US$ 410 billion, with 5 per cent of sales through institutionalized retail, meaning that the opportunity in India remains immense. Retail should continue to grow rapidly-up to US$ 535 billion in 2013, with 10 per cent coming from institutionalized retail, reflecting a fast-growing middle class, demanding higher quality shopping environments and stronger brands, the report added. Bharti Retail strengthened its position in northern India by opening 59 stores, Bharti Wal-Mart is expected to open 10 to 15 wholesale locations in the next three years, and Marks & Spencer is considering plans to open additional outlets in the next few years.

The Government of India’s Department of Consumer affairs in collaboration with the Indian Council for Research on International Relations (ICRIER) has published FDI in Retail Sector INDIA in June 2005. The study strongly advocates that “foreign direct investment should be allowed in retailing since it would speed up the growth of institutionalized formats,” without offering any valid reasons as to why the growth of “institutionalized formats” is so important. It further states, “In the initial stage FDI upto 49% should be allowed which can be raised to 100% in 3 to 5 years depending on the growth of the sector. FDI cap below 49% (i.e. 26%) would not bring in the desired foreign investment.” It admits “Foreign Retailers have pointed out that setting up of manufacturing base in India is difficult since the infrastructure is poor, labor laws are unfriendly, etc.”11 If this ridiculous argument is carried to its logical limit, India will then have to import just about all manufactured goods.

FDI in retail trade talk of how ultimately the consumer is benefited by both price reductions and improved selection, brought about by the technology and know-how of foreign players in the market. This in turn can lead to greater output and domestic consumption.

So far the Indian economy has been heavily geared towards the service sector that contributes 56% of our GDP. The service sector’s contribution to the increase in GDP over the last 5 years has been 63.9%. Having a high contribution from services is an attribute that is characteristic of developed economies. What is anomalous in the Indian case is the fact that in other fast developing economies, say China, manufacturing accounts for a significant share of GDP, whereas in India, manufacturing contributes a mere 23.1% of the GDP.

It is evident that the manufacturing sector has been the engine for economic growth in China, which has been growing at 10.1% since 1991.22 In India; the credit for its 5.9% growth over the corresponding period goes mostly to the service sector. Ironically it would seem that the Indian economy is getting a post-industrial profile without having ever been industrialized!

Retailing is not an activity that can boost GDP by itself. It is only an intermediate value-adding process. If there aren’t any goods being manufactured, then there will not be many goods to be retailed! This underlines the importance of manufacturing in a developing economy. One could argue that the alarmingly low contribution of industry is attributable to the structural adjustments going on in the sector, getting rid of the flab and getting ready to compete, but that still cannot undermine the seriousness of the issue at hand, in that only 6.22 million out of a productive cohort of 600 million is employed in institutionalized manufacturing.

Gradual opening up of the retail segment for FDI will work to the advantage to both the consumers and existing retailers. While consumer will have variety of global standard branded goods and services to choose from and that too at reachable cost. The existing retailers will be saddled with a host of unseen opportunities like joint ventures with foreign partners apart from avenues to upgrade their technologies, systems etc.

More importantly FDI in retail in India would help generating millions of jobs for the teeming jobless numbers in India. A conservative estimate puts the number of direct jobs at one million in three years. More importantly revitalized retailing necessitating a never ending supply chain of goods and services will infuse new life into the manufacturing sector, especially agriculture, food processing, small and medium enterprises and handicrafts creating avenues of indirect employment for many more millions.

At the macro level, FDI in retail will enable Indian economy to integrate with the global economy. It will help to overcome both the lack of experience in institutionalized retailing as well as lack of trained manpower. FDI in retail would reduce cost of intermediation and entail setting up of integrated supply chains that would minimize wastage, give producers a better price and benefit both producers and consumers. From the stand point of consumers, institutionalized retailing would help reduce the problem of adulteration, short weighing and substandard goods.

Conclusion:

A position paper prepared by the national retail committee of the Confederation of Indian Industry (CII) has said that FDI should be gradually allowed first in relatively less sensitive sectors. The paper argues that checks should be injected to ensure overall growth of the domestic retail industry and to create a “level playing field.” CII has stated that the domestic retailers will need at least a few years time for the kind of capital formation that is required for their growth and development. Foreign players could displace the uninstitutionalized retailers because of their superior or financial muscle and induce unfair trade activities such as predatory pricing. The local retail industry should be allowed time and given policy buffers to organize itself and meet the challenge ahead on an equal footing.

In conclusion, FDI in retail sector would certainly enable to optimize youth employment in India. For those fearing the effects of FDI in retail in India, the examples of Thailand and China should give comfort. Entry of foreign players in Thailand and China gave a big boost to retail and the exports in both countries got a shot in the arm. Notwithstanding the mounting pressure from left wing parties, the present Indian government has decided to allow FDI in retail outlets meant exclusively for single brands which mean that multinationals can invest upto 51% in joint ventures for marketing their premier brands. However, the policy certainly needs a relook and should evaluate measures for further liberalization to invite FDI in this sector to optimize youth employment opportunities