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Foreign Direct Investment in Retail Sector

November 29, 2011

The retail industry in India is of late often being hailed as one of the sunrise sectors in the economy. AT Kearney, the well-known international management consultancy, recently identified India as the ‘second most attractive retail destination’ globally from among thirty emergent markets. It has made India the cause of a good deal of excitement and the cynosure of many. The retail industry is definitely one of the pillars of the Indian economy.

The Indian retail sector is poised to witness a seachange. The recent times have seen a significant discussion emanating towards allowing FDI inmulti brand retailing. However, as a major decision, the cabinet on Thursday, 24thNovember, 2011 approved 51% FDI in multi-brand retail paving the way for global giants like WalMart to open mega stores in cities with population of over one million. The press note in this regard will be issued shortly. This is sure to have a game changing impact on the modern retail sector in India.

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.

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 kiranashops, 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.

Foreign Investment in India is governed by the FDI policy announced by the Government of India and the provisions of the Foreign Exchange Management Act (FEMA), 1999. The Reserve Bank of India (‘RBI’) in this regard had issued a notification, which contains the ForeignExchange Management (Transfer or issue of security by a person resident outside India) Regulations, 2000. This notification has been amended from time to time.

The Ministry of Commerce and Industry, Government of India is the nodal agency for motoring and reviewing the FDI policy on continued basis and changes in sectoral policy/ sectoral equity cap. The FDI policy is notified through Press Notes by the Secretariat for Industrial Assistance (SIA), Department of Industrial Policy and Promotion (DIPP).

The foreign investors are free to invest in India, except few sectors/activities, where prior approval from the RBI or Foreign Investment Promotion Board (‘FIPB’) would be required.

FDI Policy with Regard to Retailing in India

We will have to consider Press note 4 of 2006 issued by DIPP and consolidated FDI Policy issued in 2010 which provide the sector specific guidelines for FDI with regard to the conduct of trading activities. In lieu of the same:
a) FDI up to 100% for cash and carry wholesale trading and export trading is allowed under the automatic route.
b) FDI up to 51 % with prior Government approval (i.e. FIPB) for retail trade of ‘Single Brand’ products, subject to Press Note 3 (2006 Series).
c) FDI was not permitted in Multi Brand Retailing in India
However as a result of the cabinet’s decision on 24th November, 2011, points b & c above have undergone a change wherein:
b) FDI up to 100 % is allowed for retail trade of ‘Single Brand’ products.
c) FDI is permitted in Multi Brand Retailing upto 51%.

The press note on the guidelines to be followed in this regard is awaited.

100% FDI in cash and carry wholesale trading

100% FDI is allowed in wholesale trading which involves building of a large distribution infrastructure to assist local manufacturers.The wholesaler deals only with smaller retailers and not Consumers. Metro AG of Germany was the first significant global player to enter India through this route.

FDI upto 100% in Single Brand Retail

In single-brand retail,  FDI limit of 51% was allowed, subject to Foreign Investment Promotion Board (FIPB) approval and subject to the conditions mentioned in Press Note 3 that (a) 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), (b) products should be sold under the same brand internationally, (c) single-brand product retail would only cover products which are branded during manufacturing and (d) any addition to product categories to be sold under “single-brand” would require fresh approval from the government.  The FDI limit in single-brand retailing has been increased from 51% to 100% by the cabinet on 24th November, 2011.

While the phrase ‘single brand’ has not been defined, it implies that foreign companies would be allowed to sell goods sold internationally under a ‘single brand’, viz., Reebok, Nokia, Adidas. Retailing of goods of multiple brands, even if such products were produced by the same manufacturer, would not be allowed.

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 and not the Reebok brand, for which separate permission is required. If granted permission, Adidas could sell products under the Reebok brand in separate outlets.

The DIPP has justified increasing FDI limit to 100 percent in single-brand retail trading as no “significant break from existing policy” where the majority ownership of 51 per cent confers the right to pass ordinary resolutions. It has asserted that the 100 per cent ownership would bring “global best practices” in management, quality, design, packaging and production to India. It would also incentivise local producers to “scale-up” their production that would create multiplier effect on employment and income generation.

FDI upto 51% in Multi-Brand Retail Trading

In July 2010, Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce   circulated a discussion paperon allowing FDI in multi-brand retail. The paper doesn’t suggest any upper limit on FDI in multi-brand retail.
Acting on the recommendations of the DIPP, the Committee of Secretaries (CoS) headed by Cabinet Secretary, Ajit Kumar Seth, cleared the proposal to allow FDI in multi-brand retail. The FDI is pegged at 51% and the foreign investor would have to bring in US$ 100 million as investment, restricted to only Tier I cities. Tier I cities are those with populations over 1 million. This latest development certainly does come as a shot in the arm as far as FDI in the retail business is concerned. Retail is capital intensive sector and the increased availability of funds coupled with the imminent presence of foreign players promises to add a whole new dimension to the sector. Retailers ought to take cognizance of the fact that both back-end and front-end operations require investment and hence, need to be developed in a manner commensurate with their overall business operations.The decision of the government in opening up FDI in multi-brand retail will mean that global retailers including Wal-Mart, Carrefour and Tesco can open stores offering a range of household items and grocery directly to consumers in the same way as the ubiquitous ’kirana’ store

The remaining conditions for multi-brand retail FDI mirror the CoS report. We will have to see if there are any changes in these conditions in the press note which is expected to be released next week:

  • Minimum amount of FDI by a foreign investor would be $100 million.
  • At least 50 per cent of total FDI will be invested in “back-end infrastructure,” which will include investment on processing, manufacturing, distribution, design improvement, quality control, packaging, warehouses, storage, logistics and related infrastructure.
  • At least 30 per cent procurement of manufactured or processed products shall be sourced from small industries that don’t have plant and machinery more than $1 million worth.
  • Multi-brand retail outlets can sell unbranded fresh agriculture produce, including fruits, vegetables, flowers, grains, pulses, fresh poultry, fishery and meat products
  • Retail sales locations will be set up in cities with a population of more than 10 lakh according to 2011 census and will cover an area of 10 km around the municipal limits of such cities.
  • Government will have the first right to procurement of agricultural products

Rationale for FDI in retail trading

FDI in the retail sector could bring in various benefits for the country, such as:

Improvement in the supply chain infrastructure by bringing in technical know-how and capital: FDI can be a powerful catalyst to spur competition in the retail industry. It will help generate funds for developing “post-harvest and cold chain infrastructure while incentivising international retailers to introduce latest technology and adopt international best practices.

Improvement in farmer income through the removal of structural inefficiencies: Farmers were found to benefit significantly from the option of direct sales to organized retailers. For instance, the profit realization for farmers selling directly to the organizedretailers is expected to be much higher than that received from selling in the mandis.

Benefits to customers in the form of better quality of products and lower prices:Past trends indicate that by and large consumers have benefited from organized retail in the domestic market.
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.

Source : Discussion paper circulated by Department of Industrial Policy and Promotion (DIPP), Ministry of Commerce   and recent articles in the media.

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