India: Opening up retail

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Faced with a subdued economic prognosis, in September the government introduced a law that will relax regulations for foreign direct investment (FDI) and ease the business environment for foreign entrants to the retail sector. The politically sensitive ruling, issued on September 20 by the Department of Industrial Policy and Promotion, allows for 51% FDI in multi-brand retailing and comes swiftly on the heels of a September 14 cabinet ruling that relaxes the sourcing norms for foreign retailers investing beyond 51%.

While the decision has received immediate criticism from opposition parties, the government of the United Progressive Alliance has said the regulation will provide a timely boost to an ailing economy. Mohit Bahl, the executive director of transaction services at KPMG India, a global financial and business advisory firm, told OBG that the regulation “has been overdue”. According to Bahl, a number of factors have led to the recent decision, including a slowdown in economic growth and doggedly high inflation driven by food prices, which stood at 7.55% in August.

“The inflationary environment has been quite high in the past 18 months, and there is a belief that we need a structural change and improved efficiency in the supply chain to bring more rational pricing. So the government is thinking that we need to open [the sector] up to retailers that can improve this,” Bahl said.

Although an injection of FDI is unlikely to curb inflation in the short term, it is seen as a welcome balm for a faltering economy that is also suffering from a burgeoning current account imbalance. In mid-September, Prime Minister Manmohan Singh told the Press Trust India that FDI is needed to deal with the problem of the current account deficit, a position shared by the Reserve Bank of India (RBI). The current account deficit stood at 4.2% of GDP at the beginning of October and is estimated to average 2.9% of GDP over the lifespan of the current five-year plan (2012-17).

The recent announcement should help the country to build on a dramatic improvement in capturing FDI in the past decade. According to the RBI, FDI inflows grew from $6bn in 2001-02 to almost $38bn in 2008-09. However, Indian FDI fell by 31.5% to $23.7bn in 2010. This placed the country 7th among developing economies in terms of FDI, according to the World Investment Report and the Global Investment Trends Monitor of the UN Conference on Trade and Development (UNCTAD).

The positive wave of inflows following the liberalisation of the economy in the 1990s, therefore, has begun to stall. While this is partially a result of the global economic slowdown, there have been calls to bolster the business environment with a further liberalisation of investment laws. Indeed, many emerging market economies witnessed strong FDI growth in the 2010-11 period.

India, meanwhile, has struggled, as a result of procedural delays and overregulation, according to reports by the Federation of Indian Chambers of Commerce and Industry and CRISIL, a global analysis and research firm. The government already allows 100% foreign ownership in many sectors, including agriculture and industry, but the introduction of a new regulation allowing 100% foreign investment in single-brand retail in January 2012 was seen as a further commitment to opening up the business environment in India.

While the new law is likely to build on this, Bahl told OBG that the impact in the shorter term is likely to be minimal. “I do not see investments being made in the coming six months. The immediate beneficiary will be single-brand retailers,” he said. “This is a reasonably good opportunity and you might see some single-brand investments in the apparel segment and restaurant chains coming in.”

However, despite the recent liberalisation of the sector, significant structural challenges remain for multi-brand retailers. The fact that the regulation will be implemented on a state-by-state basis, with 10 states already agreeing to implement the decision, will make it difficult for foreign retailers to roll out nationwide operations and a comprehensive supply chain.

More importantly, the regulation states that multi-brand retailers must source 30% of their goods from local small and medium-sized enterprises. According to Bahl, “This regulation pretty much precludes any non-food and beverage retailers from entering the market”.

Even for multi-brand food retailers, such as Walmart, that have been looking to enter the market for some time, additional regulations regarding investment size (minimum of $100m), where this must be invested (50% in back-end infrastructure in rural areas), and the limitation on where they can operate (in cities with a population over 1m people), may give pause for thought.

Nonetheless, the new ruling has largely been seen as a positive first step by investors, with the stocks of the country’s largest retail firms strengthening immediately after the announcement. In the medium term, once investors become accustomed to the new ruling, this regulation is likely to prove good news for both the country’s FDI levels more broadly and for the retail sector in particular.

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