Friday, December 19, 2014

A perspective on the Impact of FDI on the Retail Sector

By Sibin Sabu, Research Intern
Any investment made by a company or entity based in one country, into a company or entity based in another country may be called Foreign Direct Investment. As per OECD (Organization for Economic Co-operation and Development), the foreign investor must own at least 10% or more of the voting stock or ordinary shares of the investee company for it to be considered a FDI. Thus an FDI will give the investor a certain degree of influence over the management of the enterprise.
Foreign investment in India is regulated by the RBI and the Foreign Investment Promotion Board (FIPB) under the Department of Economic Affairs, Ministry of Finance. FDI is not permitted in all sectors in India. The government has prohibited FDI in Atomic Energy, Lottery Business, Gambling and Betting, Business of Chit Fund etc.
Retail Market in India in 2011
Any person or business selling goods to a consumer may be called a retailer. Therefore, wholesalers and suppliers are not considered as retailers. The retail sector accounts for around 15% of GDP and is the largest component of service sector in terms of contribution to GDP. Retailers may be broadly classified into organized retailers (those registered for Sales Tax, Income Tax etc) and unorganized retailers (small local shops). In most of the developed nations, the penetration of organized retail market is usually well over 50%. A major reason for this is FDI in the retail sector.
Until 2011, Indian government did not allow FDI in multi-brand retail, forbidding foreign investors from any ownership in supermarkets, convenience stores or any retail outlets. Even single-brand retail (eg: Reebok, Nike) was limited to 51% ownership and a bureaucratic process. Not surprisingly, organized retail accounted for only 7% in 2011 and the food and grocery Sector which accounts for two-third of retail in India had only 2% organized retailing. In terms of retail sales, only $27 bn out of $470 bn came from organized retailing in 2011.
The FDI reforms in Retail (2011)
In order to tap the potential and advantages of organized retailing, the UPA Government under Dr.Manmohan Singh introduced significant reforms in the retail sector in November and December of 2011. Government allowed 100% FDI with 30% local sourcing requirement in single brand retailing and 51% FDI with no sourcing requirements. The government permitted 100% FDI in cash and carry also.
In multi-brand retail it permitted 51% FDI subject to certain conditions. It should operate only in cities with population in excess of 1 Million and with 30% sourcing from MSME, along with capital and supply chain investment requirements.  Multi-brand retailers must have a minimum investment of US$100 million with at least half of the amount invested in back end infrastructure, including cold chains, refrigeration, transportation, packing, sorting and processing to considerably reduce the post harvest losses and bring remunerative prices to farmers.
However, the opening of retail competition will be within India's federal structure of government. Thus states of India have the prerogative to accept it and implement it. Even though most of the Congress led states supported the initiative, the communist party is against the move and BJP is strongly opposed to introduction of FDI in multi-brand retail. Hence, even though it is estimated that around 53 cities out of some 7935 towns and cities in India has a population over one million, only 18-20 cities are expected to allow FDI in retail.
What Opponents to this Reform Say
The government’s bold decision to allow FDI in retail did not go down well with the political parties who sharply criticized the government for introducing reforms that will put millions of local shop owners out of business. The move has had several opponents, especially in the political circles, with various reasons being cited to justify their stand.
Opponents argue that, in addition to eliminating the middle-man, suppliers might also be pressured into taking lower margins. Over time, this will reduce the local economy since the small retailer and the middle man play a large part in supporting the local economy by procuring goods and services from the locality. Large retailers, on the other hand, usually acquire goods from other regions and foreign markets, hence reducing the local economy.
They also argue that retailers like Walmart will lower prices to eliminate competition and become a monopoly after which they will charge exorbitant prices. This was allegedly the case of the soft drinks industry (eg: Pepsi and Coca-Cola). However, this is very unlikely to happen because big players like Walmart, Carrefour, Tesco etc are some of the major retail companies that have been in operation for over 30 years in numerous countries and they have not become monopolies anywhere.
Another argument commonly raised against this move is the potential job loss. In reality, it is unlikely that jobs will be lost or created with the introduction of FDI. They will simply be displaced. Those working in the unorganized sector will move on to work in the organized sector. Some jobs will be lost in the unorganized sector. But, jobs will also be created by the organized retail market in equal measure, if not more. Hence, the argument about loss of jobs is not a valid one.
Potential Impact on Key Stakeholders
The impact of these reforms on the key stakeholders presents an interesting picture. The Government is likely to witness improvements in Balance of Payments and Tax Collections while the farmers will have the opportunity to achieve better price realization due to better supply chain and lower wastages arising from better back-end infrastructure. For the consumers, these reforms could mean lower price compared to unorganized retail, better shopping experience and a wider choice.
The Indian Retailers would also benefit from the cost effective and better supplier base created by the foreign investors and will have access to better technology as well as possible capital infusion from international retailers.
For the unorganized sector, this could result in an overall increase in consumption and give them an opportunity to improve operational efficiency. The decrease in their market share, if any, is likely to be just 1-2% according to researchers by 2016.
Another factor in favor of FDI in retail is that competition between Walmart-like retailers will keep food prices and inflation in check as lower food wastage implies lesser inflation. Historically, inbuilt inefficiencies and wastage in distribution and storage account for why 40% of food production doesn't reach consumers. Food often rots in farms, in transit, or in antiquated state-run warehouses.
Cost-conscious organized retail companies will avoid waste and loss, making food available to the weakest and poorest segment of Indian society, while increasing the income of small farmers. Thus, it also offers a ray of hope for the 50 million malnourished children in our country.
The biggest gainers will be our farmers. In an agrarian economy like ours, this in fact becomes the selling point for this reform. Indian farmers get only one-third of the price consumers pay for food staples and the rest is taken as commissions and markups by middlemen and shopkeepers. For perishable horticulture produce, average price farmers receive is barely 12 to 15% of the final price consumer pays. For example, Indian potato farmers sell their crop for Rs. 2 to 3 a kilogram, while the Indian consumer buys the same potato for Rs. 12 to 20 a kilogram.
This scenario will be changed significantly with the introduction of foreign players in the market who will procure goods directly from the farmers, reducing the role of middlemen and giving much better prices for the farmers. This could thus lead to poverty eradication and economic development of farmers in our country and all known farmer associations have come out in the open supporting FDI in Retail. Apex commercial chambers such as CII and FICCI also support this initiative.
We suggest that the current BJP government review its stand on FDI in multi-brand retail and encourage foreign investors to enter our retail market. The idea of implementing this decision at select cities with population of over 1 million initially is a good one as it allows time for the market to adapt and compete with the foreign retailers. However, to make the most out of the potential of FDI, it should gradually be allowed in other states as well.
Another important point to be noted is that introducing the reform is not the end of it. It will not provide sufficient reason for an investor to invest in our country. For that to happen, the government must also develop the proper infrastructure and transport networks facilitating faster movement of goods. The government must also work towards simplifying the registration process and taxation policy. The attempt of reforming the Goods and Services Tax is a step in the right direction.
After careful analysis, we can find that the positives far outweigh the few minor drawbacks of this reform. Trade-off might be the apt word for describing the impact of FDI in retail. If we leave the politics and vested interests aside, FDI in retail should be a win-win proposition for all those involved, more so for the farmers and consumers. It should, instead, be celebrated.