This is the reproduction of an article written about FDI in response to a request by Mr. Shreekumar, Editor of the Trade Briefs magazine.
It is about six months since the Central Government passed the Law permitting Foreign Direct Investment in Multi Brand Retail. This happened after a long and very hard-fought intellectual, political and very personal battle, taking close on 10 years for this decision to come through, and the expectation was that the Worlds’ finest retailers will be queuing at the door begging to be allowed to invest in the sector. Sadly instead, it seems to have just left the retail industry in utter confusion. Let us try to understand why…
Retail Politics – is this really justified?
Currently the biggest stumbling block to Retail in India is the politics of the issue. One wonders why Retail in India has become the unfortunate victim of a completely unjustified political focus, as it is highly undeserving of it. What ought to have been a simple technical decision based on sound economics has unfortunately become an unexpected high decibel all-stakes-on-the-table battleground, pushing the Government to adopt a forced hawkish position while drafting out the notifications. These notifications, over the past few months, have churned out some very investor-unfriendly guidelines while grudgingly permitting investments under two broad sub-divisions – Single Brand Retail and Multi Brand Retail, and added with the absence of clarity in those notifications, has rendered the entire environment muddied and seemingly fraught with risk. Thus, no major Multi Brand Retailer is queuing up at the Ministry’s doors begging or otherwise – not till date, anyway, leaving just a handful of Single Brand Retailers for the Government to showcase as successes of the policy.
So, why has Indian Retail become so embroiled in politics? I really do not have the answer to that. It will take a more diligent student of Indian Politics and apparently even of Indian Retail than I to answer that one. I can say only this. Retail is a very ordinary, low-tech, basic but capital (both fiscal and human) intensive industry and it is only the implementation of globally tested best practices, intelligently adapted to suit the Indian market, together with the investment of virtually unlimited resources in the form of promoters equity that could make retail work in India. Thus, the shrillness of the political debate that retail has attracted is quite unexpected. The NDA Government, in 2004 had the opening up of this sector in their Manifesto, but chose to 'U turn' on it in 2009. The UPA Opposition in 2004, who was then the shrillest opponent of FDI in Retail, is now the one who is saying it is the panacea for the nation in 2012. Neither position is entirely justified, as Retail is neither a bed of roses nor an instrument of destruction, but a simple, down to earth and an exceedingly tough business. The NDA opposition has even vowed never to permit this notification in States ruled by them and is even ready to bring down the Central Government for this law, despite it being promulgated at least 10 years too late by their own reckoning.
Thus, it is evident that both political alliances have been working only for their own short-term benefit than to formulate policy for the good of the industry and the nation for the long term. Poor politics has been killing good economics for over a generation now, and this has been proved true in the case of Retail in India too. Will politicians ever change and see the big picture? Will the UPA Government ever have the sagacity to seek the NDA’s support for a slightly modified bill and end this atrocious debate once and for all? Will the NDA show the required bipartisanship that would be necessary? Ultimately, can they agree to share the credit (or the blame), as the case may be? My expectations are unfortunately abysmal on that count.
Confusion in Single Brand Retail
Instead of the promised flood, investments in Single Brand Retailing have been dribbling in principally due to the rule that mandates 30% local sourcing from launch of business. Any retailer would find that a challenge, and virtually every one of the current applicants have requested a clarification on this rule. Even a cursory internet search on this subject throws up a number of stories that speculate that the rule will be diluted soon and an equal number that disdainfully insist that that will never happen. One is appalled that we as a nation have the gall to invite investment in this cloak and dagger manner, and one is equally amazed that the world’s finest retailers are still taking us seriously after all this! In my view, ‘Single Brand Retail’ is not even a genuine and cogent classification (more on this later), and if it were to exist, this rule that defines the quantum of local sourcing must be enforced in a phased manner over a 5-year period in the least. While the silly season on this rule is not in a hurry to end anytime soon, some sense needs to prevail and the Government must not insist that the sourcing should be made only from SME’s, and should be extended to cover any Indian manufacturer, regardless of size, as it would be difficult enough to launch with some quantum of local sourcing, and the larger corporates may be better placed than SME’s to match the specification requirements.
Further, as the rule currently reads, an SME who would be trained and developed with much effort to supply quality merchandise by a global retailer has to be dropped as soon as his turnover crosses USD 1.0 Million as he then becomes ineligible. The retailer, who spends a lot of time and effort in developing a reliable resource and enriches him in the bargain by sourcing from him, has to dump this supplier and search for a new one. Does this mean that we intend to punish success, or perhaps encourage subterfuge as vendors will open an unlimited number of new companies each having a turnover of less than a USD 1.0 Million to skirt around the silly law? Is this desirable?
The odd-ball rules of Multi Brand Retail
Multi Brand Retailing is in an even worse bind if that were possible. Apparently, this Government, which has been accused of policy paralysis for too long has decided that it is best to promulgate any ‘paralyzed policy’ with a view to just ducking some heat from the WTO and investor lobby groups! That is perhaps why a major policy reform announced by the Center requires the separate endorsement of every State Government. This is preposterous. This is perhaps the first Central Government economic policy that is not applicable by law all over the country automatically. Thus, this policy, which leaves the adoption of the rule or of dropping it to the States, is a very confusing and spineless one, and is scaring off even the most pioneering of foreign investors, as they have to ensure that all the States that they intend to operate in has adopted their version of the law, before doing business there.
Perhaps, a new retail entrant into the country will have a somewhat lesser cloud of confusion hanging over their heads, as they can in theory; pick and choose to enter only those States that have adopted the new rules. While this is possible in theory, it is highly unlikely for a major retailer to agree to invest in the country if he is not even sure of how many states he can operate in, and how many stores he can ultimately build in his chain. If one is not sure of one’s operational scale in the medium term, one is sure of nothing, how will the investment come in?
On the other hand, for an international Multi Brand Retailer who is interested in buying into an existing Indian chain the situation is simply hilarious. For instance, Future Retail* will have to perhaps split into multiple business entities each registered in various State Capitals and the investor can own 51% of only those entities that are registered in States that have adopted the new rules. Assuming this is done, what happens to the Brand name of the retail chains in question? You cannot have a 100% Future Group entity and a 49% Future Group entity both owning the same Brand Name, so the Brand Name cannot be sold off. Thus, without the ownership of the Brand Name and the goodwill it carries, what would be the use of investing in that chain?
Even if all the above is somehow navigated, the ever-present problem of multiple Taxation Circles and Entry Tax Rules continue to exist and complicate any investment proposal. The adoption of a uniform Tax Code and the GST Act will also be a pre-requisite for a retailer who aspires a pan-India footprint.
The politics of the Multi Brand Retail has also mandated that all retailers will have to invest a minimum sum of USD 100 Million, of which 50% will have to be deployed in the development of back-end processes. Where is the logic in this? Which retailer, other than a Food / Fresh Produce retailer requires any substantial back-end set up? Will an Electronics and IT Equipment Retailer ever require the investment of USD 50 Million worth in his back-end operation? Will that investment not be a millstone around his neck, dooming him from profitability in a low-margin business? Judging from this and other ham-handed rules, it is quite clear that the understanding of the sector by the Government bureaucrats is very poor and they have been guided largely by political dividend.
Debate on the relevance of the classification – Single and Multi Brand Retail
Another aspect of the debate that has befuddled me no end is the seemingly senseless and unnatural segregation of Retail into ‘Single Brand Retail’ and ‘Multi Brand Retail’. The business approach, the investment requirements, the mode of operation and products being sold in retail do not fall under the above classification and vast overlaps are seen. My reading is that this classification was conjured by the Government, on the premise that it expected less resistance to Single Brand Retail, and hence perhaps hoped that it could manage to get at least some investment through the back door. Obviously, the ploy has not worked, and one has learnt that less than ten 'Single Brand Retailers' of repute have made a formal application at the time that this was written. Many others would adopt a wait-and-watch approach and wait the situation out.
Looking at the minefield that the rules of Multi Brand Retail are, I do not expect even a single serious Retailer to put his money here, considering the serious risks involved. One has even heard the NDA politicians say that they will rescind the notification if they capture power in the next Lok Sabha. Investment will come only when there is complete clarity, and the investor is sure that his estate is safe. I have personally heard from a prospective investor that, even in a restrictive 26% FDI regime, that has a clearly framed rule structure, he would be tempted invest in India, considering the innate attractiveness of the Indian market, but with all the confusion hanging over our 51% and 100% regimes, he would be wary of putting in any money. Thus, it is clear that for both Single Brand and Multi Brand Retail, one would not expect the investment flood gates to open anytime soon. The Government will need to actively work with the industry and revise their approach to the regulation of FDI.
Food Retail and Non-Food Retail makes more sense as a Classification
A more logical and cogent classification of Retail in India would be one that is split along the lines of ‘Food Retailing’ and ‘Non Food Retailing’ which would be more appropriate for the Indian scenario. The back-end investments and Farm-to-fork initiatives are very relevant to Food Retailing, and insisting on investments in this sector would not be misplaced. State Governments would then be able look at the Retail industry from this paradigm and formulate the rules as required of them by the Central Government, keeping in mind all the local sensitivities to Food Retailing.
One can readily understand the political sensitivity of food retailing, as millions of small retailers’ livelihoods are apparently in danger by the advent of modern retail and hence requiring of some protection, but why do we have all kinds of retail clubbed together? What are the risks in permitting retail of let us say, Apparel, Accessories, Books, Stationery, Consumer Durables, Cosmetics, Jewelry and a host of other FMCG and Lifestyle goods and services by Multi-national Retailers? Why should we insist that they invest USD 50 Million in infrastructure? Would that huge investment be justified and pay for itself financially?
This artificial Clubbing together of all types of Retail regardless of the type of business structure or product cycle is ham-handed and ill-conceived as it would surely be counterproductive - both to the politics of the issue and for the retail industry, not to mention – to the nation as a whole too. While one can understand the social context of Food Retail needing to be restricted to ensure that the political agenda is adequately addressed, one firmly believes that Non-Food Retail should be simply removed from all unnecessary controls and allowed to propagate freely.
Retailers need access to the traditionally developed markets in India
Retailers also need to be assured that they can freely operate in all the developed markets of India, where modern trade has been in vogue for about 20 years like Tamil Nadu, Karnataka, Andhra Pradesh, Maharashtra, Gujarat and NCR. Without a presence in all these key markets, one would not want to venture into new and untried markets that have welcomed FDI in retail. One hopes that perhaps when provided with this new perspective, State Governments that are politically adversarial to the Central Government, but possessing an otherwise progressive outlook, may be more inclined to notify their own versions of the Retail rules and perhaps choose to closely monitor Food Retail while permitting Non Food Retail to proliferate as that poses no political concerns to be addressed.
For most International Retailers however, the markets of Tamil Nadu, Karnataka and Andhra Pradesh would be the most attractive, as modern Retail (FMCG, Food) has been extensively tried and tested here since the mid 1990’s, due to which the customers are expected to be more welcoming of the USP of Modern Retail. Further, as they are also progressive States, their denizens possess good purchasing power, while also enjoying a relatively politically stable and generally peaceful business oriented atmosphere. I wouldn’t be very surprised if many International Brands choose to postpone their entry into India until these crucial States notify their version of the rules. Sadly, currently only Andhra Pradesh has fallen in line.
This would be particularly critical for Karnataka, and it needs to look at this very closely and very seriously as many international retailers would be keen to be headquartered in Bangalore, considering the fact that it is the most preferred city to live in for expat managers. Thus, if Karnataka continues to choose political exigency over sound policy and economics, they will stand to lose a huge opportunity in the form of being the repository for all the investment and being the beneficiary of the tax revenues accruing out of such business entities.
Business and politics aside, I for one, truly believe from the bottom of my heart that modern retail will genuinely and substantially benefit India, especially with the rules mandating a 50% quantum of investment in the setting up of Retail Backend Infrastructure, if that is focused towards Food Retail. I draw attention to another article of mine, where I have written about the need for the betterment of the agricultural infrastructure (please see link below), which I feel large retailers would be most willing to undertake, if the rest of the rules are more investor friendly. I do hope that someone out there is listening….
* The Retail Entity has been named only for illustration purposes and not with any other intent. However, the scenarios mentioned above would be equally true for virtually all other Indian promoted retail chains too, and many of which are on the edge of financial ruin and a few of them may be open to an equity infusion at this point in time.