FDI in Retail: Regenerated enthusiasm amongst foreign investors

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The Economic Times

Gaurav Karnik
Tax Partner, EY

Thursday, 24 November 2011, will be remembered as landmark day when Government finally cleared the proposal of 51% foreign direct investment (FDI) in multi-brand retail and 100% in single brand retail. Amidst, the strong political opposition and policy inertia over the past couple of years, this move is a giant welcome leap towards further economic liberalization.

India's young population, higher disposal income, up gradation in living standards coupled with growing consumer demand has made India an attractive destination for foreign direct investment, especially, for global retailers given the current economic uncertainty prevailing in the global economy.

Given the business community and investor confidence is low at the moment, the liberalization of the FDI policy vis-à-vis retail should go a long way in shoring up confidence and provide a fillip to further investments.

The liberalization of FDI in retail will lead to increased FDI inflows in the following buckets:

  • Foreign investors who earlier wanted to foray only in multi-brand 'retail' and not the watered down avatar of' wholesale cash and carry 'will now be keen to enter India.
  • Hike in the limit for FDI in single brand joint venture, will enable foreign investors to increase their stake in the existing ventures where the Indian joint venture partner are unable to further capitalize the ventures keeping their 49 percent stake in perspective.
  • Global single brand players who did not want to enter into India earlier because of 51% cap prescribed for single brand retail should be interested in investing into India.
  • Foreign investment in already existing large and medium Indian retailers to address their funding needs.

The rationale adopted by the Government of India for opening up of the retail sector for foreign investments is as follows:

  • Although, India is the second largest producer of fruits and vegetables, India lacks an integrated cold-chain infrastructure and storage facilities. Inefficient supply chain infrastructure is evident from the fact that 35-40% of the fruits and vegetables and nearly 10% of food grains in India are wasted.
  • 100% permitted FDI in cold-chain storage has failed to attract desired foreign investment, in the absence of FDI in front-end retail, leading to losses to farmers in terms of higher prices; wastage of quality and quantity of produce.

The opening of FDI in retail with the condition of 50% mandatory investment in backend infrastructure should help in overcoming the above supply chain inefficiencies. Back-end infrastructure will include activities, like processing, manufacturing, distribution, design improvement, quality control, packaging, logistics, storage, ware-house, agriculture market produce infrastructure etc. Expenditure on land cost and rentals, if any, will not be counted for purposes of backend infrastructure.

Currently, illiteracy at farm level and outdated means of production and lack of required infrastructure has also contributed to shorter shelf life of the product and increased wastages. Global retailers are expected to bring in advanced technology; know-how and years of experience which should go a long way in addressing these inconsistencies. It is expected that the investments in supply chain by such global retailers should help in taming inflation currently prevailing in the Indian economy.

Numerous concerns have been articulated with regard to opening of the retail sector for FDI. It has been debated that opening of the sector to overseas big-ticket players would lead to inequitable competition resulting exit of domestic retailers, leading to large scale displacement of persons employed in the retail sector. One should not forget that even kirana stores are today confronted with high transaction cost due to lack of efficient supply chain management. It is pertinent to note that opening up of FDI in multi brand retail in other countries, has not only resulted in substantial growth in organized retail industry, but also seen an increase in the number of smaller unorganized sector stores.

Amongst other benefits, the opening up of multi-brand retail will have positive impact on the overall economic growth owing to increased employment opportunities; increased demand of real estate; better infrastructure; reduction in prices of the final product; fair remuneration to the farmers.

The Government has also adopted a cautious approach, while opening up FDI in retail to foreign investors. The same is evident from the fact that FDI in multi-brand retail is being opened in 53 cities only with population of 1 million. Accordingly, for the rest of the country the current FDI regulations of 100% FDI only in wholesale cash and carry would prevail. Additionally, the press release issued by the Government also stipulates a mandatory 30% procurement of manufactured / processed products from SMEs in respect to multi-brand and single brand proposal involving FDI beyond 51%.

Concluding thoughts

The much awaited Union Cabinet pronouncement of opening of FDI in retail is a well thought out move and should be welcomed by the global investor community and the Indian economy at large. Although, the liberalization is accompanied by certain riders, these riders should not act as a deterrent for the global retailers for actioning their long drawn out plans for entry into India. The Government deserves kudos for undertaking such a bold reform, which should provide much needed fillip to foreign investment in India.