FDI in Retail: Catalyst for Change

FDI in Retail: Catalyst for Change

Swaniti Initiative | November 21, 2012 | The Swaniti Blog

Writing For The Motion: Rajiv Ranjan and Amit Agarkhed
Rajiv and Amit are first-year PGP students at IIM-Ahmedabad.

In today’s fast-globalizing world, foreign investment is crucial to a country’s economic growth. There is increasing competition among nations to attract foreign investment to spur economic growth. Foreign investment comes in two major ways: foreign direct investment (FDI) and foreign institutional investment (FII).

FDI is usually preferred over other forms of external finance because it is non-debt creating, non-volatile, and its returns depend on the performance of the projects financed by the investors. FDI facilitates international trade by promoting transfer of knowledge, skills, & technology. In a world of cut-throat competition and rapid technological change, FDI’s complimentary and catalytic role can be very valuable.

Though FDI is welcome in India, it is not permitted in sectors like arms & ammunition, atomic energy, railway transport, coal & lignite and mining of iron. Also in place are some restrictions on the percentage of FDI allowed in sectors. For example, the ceiling on FDI in insurance companies is 26 per cent.

Some of the sectors that attract high FDI are software and hardware, telecommunications, construction activities, automobile industry, housing & real estate, power, chemicals, and drugs & pharmaceuticals.

The possibility of getting access to modern technology is perhaps the most important reason why countries wish to attract foreign investment. By inviting multinational corporations (MNCs), host countries may get access to technologies that they cannot produce by themselves. Foreign direct investment can also lead to indirect productivity gains for host country firms through the realization of external economies. Generally these benefits are referred to as “spillovers”, which indicates the importance of the way in which the influence is transmitted.

There are several ways in which technology spillovers may occur. Multinational firms may, for instance, increase the degree of competition in host—country markets and in that way forces existing inefficient firms to make themselves more productive by investing in physical or human capital. MNCs may also provide training of labor and management which may then become available to the economy in general. Another possible channel for spillovers is the training of local suppliers of intermediate products to meet the higher standards of quality control, reliability, and speed of delivery required by the technology and method of operation of the foreign-owned company.

There is strong evidence that multinational firms have contributed to a geographical diffusion of technology end that active host countries can get access to modern technology via foreign direct investment. With the increasing global interdependence in the economic and technological spheres it can also be expected that multinationals will remain an important vehicle in the international diffusion of technology.

Turning to the furor on FDI in retail sector in the Indian political arena, I will like to start with famous Henry Ford adage – “Don’t find fault, find a remedy” .This adage reverberates ever so relevantly in today’s Indian retail sector scenario like never before. For more than a year, every problem in India has been blamed on the incumbent government by national and international lobbies and “Policy Paralysis” has been the reason cited for every shortfall including the falling rupee, the worsening fiscal deficit, high inflation, high interest rates and delayed capital expenditure plans. On September 14, 2012 the government broke the shackles and came out with the much needed and highly anticipated reforms regarding Foreign Direct Investment (FDI) in the Multi-brand Retail Sector of India with a surety of no roll-back this time these reforms will create price competition and remove the multiple layers of inefficiency between the farmers and the final retailer and hopefully help the farmers and producers of goods realize a bigger share of the pie in the long-run Given the current negative sentiment of foreign investors (post Vodafone and Draft GAAR Guidelines) and the lack of capital inflows in India, these reforms will encourage foreign firms to give India a serious look and encourage them to invest capital in the country As foreign firms who partner with local Indian firms are able to generate profits and achieve success in India it will encourage FDI in other sectors as well and create a positive image for India globally as a fruitful business destination.

Multi-brand retail, if allowed, is expected to transform the retail landscape in a significant way. Firstly, the organized players would bring in the much needed investment that would spur the further growth of the sector. This would be particularly important for sustenance of some of the domestic retailers that don’t have the resources to ride out the storm during an economic slump such as the case with Vishal, Subhiksha and Koutons, which couldn’t arrange for funds to sustain their growth. Secondly, the technical know-how, global best practices, quality standards and cost competitiveness brought forth through FDI would augur well for the domestic players to garner the necessary support to sustain their growth. Thirdly, Indian has also been crippled by rising inflation rates that have refused to come within accepted levels. A key reason for this has been attributed to the vastly avoidable supply chain costs in the Indian food and grocery sales which has been estimated to be a whopping US$ 24 Bn. The infrastructure support extended to improve the backend processes of the supply chain would enable to eliminate such wastages and enhance the operational efficiency. Fourthly, FDI in multi-brand retail would in no way endanger the jobs of people employed in the unorganized retail sector. On the contrary, it would lead to the creation of millions of jobs as massive infrastructure capabilities would be needed to cater to the changing lifestyle needs of the urban Indian who is keen on allocating the disposable income towards organized retailing in addition to the local kiryana stores. These stores would be able to retain their importance owing to their unique characteristics of convenience, proximity and skills in retaining customers. Also, these would be more prominent in the Tier-II and Tier-III cities where the organized supermarkets would find it harder to establish themselves. Fifthly, the numerous intermediaries would be restricted and therefore, the farmers would get to enjoy a bigger share of the pie. FDI in multi-brand retail is therefore a necessary step that needs to be taken to propel further growth in the sector. This would not only prove to be fruitful for the economy as a whole but will also integrate the Indian retail sector with the global retail market. It is not a question of ‘how’ it will be done but ‘when’.

This marks an opportune moment for all, the big domestic players, fringe kiryana Stores and the foreign giants to co-exist in India. The Wal-Mart model which offers daily low pricing, but are located in far-off places, with a homogenous set of products across their stores, typically need large space and require a personal commuting vehicle to get to. Our country is years away from when the majority population will have the ability to shop only at the big retail chains. Competition will force the kiryana Stores to upgrade their current standards, increasing their price competitiveness, quality goods at reasonable prices and infuse in them customer relationship management (CRM) i.e., keeping proper records of customers. Many people will still shop there for proximity, comfort of relationship and easy credit. Foreigners will bring to India their expertise and efficiency in retailing, they will invest capital in improving logistics and infrastructure in India (for example: Cold Storage Logistics is still almost non-existent in India) and share technology and know-how with their local Indian Partners, but will also be able to become profitable over a period of time as their brands and presence increase across the country Hopefully, the Domestic Giants will learn the best practices from their foreign counterparts and just as in Brazil foreign retailers thrive but still a local player is the most dominant(Pao de Acucar), India will see a much more inclusive and efficient Retail Industry. On the whole, if India has to grow it needs capital, training and innovation in this sector. Yes the short-term effects of the announced reforms will be a bit painful, but in the long-term they will help make Indian retail sector a more organized industry, providing better quality goods at convenient locations at cheaper prices, improving infrastructure and the supply chain mechanism throughout the country, providing employment and retail sector specific training to a large population which will be a huge boon to the nation. Foreign Retailers who are looking to make a quick profit are better off investing elsewhere. But those who are willing to be patient and make a more long-term bet on India definitely have the opportunity to “HIT THE BULLS EYE.” India is a virtually untapped and a huge growing market in terms of the Organized Retail Industry ($450bn industry, with only 5-6% organized retail).The foreign players who are willing to learn from their mistakes in other emerging markets and early experiences in India, go through a careful partner selection process, understand the political, legal, external hurdles and invest with a realistic time horizon truly have an unique opportunity to create win-win situations for all stakeholders. Several other sectors have seen foreign entrants with a successful and profitable model in India (Dominos, Citigroup, Honda etc.). Our view is that the FDI in Retail will unfold in a similar manner in the times to come.

FDI can be a powerful catalyst to spur competition in the retail industry, due to the current scenario of low competition and poor productivity. The policy of single brand retail was adopted to allow Indian consumers access to foreign brands. Since Indians spend a lot of money shopping abroad, this policy enables them to spend the same money on the same goods in India. Permitting foreign investment in food-based retailing is likely to ensure adequate flow of capital into the country & its productive use, in a manner likely to promote the welfare of all sections of society, particularly farmers and consumers. It would also help bring about improvements in farmer income & agricultural growth and assist in lowering consumer prices inflation. Apart from this, by allowing FDI in retail trade, India will significantly flourish in terms of quality standards and consumer expectations, since the inflow of FDI in retail sector is bound to pull up the quality standards and cost competitiveness of Indian producers in all the segments. It is therefore obvious that we should not only permit but encourage FDI in retail trade. Lastly, it is to be noted that the Indian Council of Research in International Economic Relations(ICRIER), a premier economic think-tank of the country, which was appointed to look into the impact of BIG capital in the retail sector, has projected the worth of Indian retail sector to reach $496 billion by 2011-12 and ICRIER has also come to conclusion that investment of ‘big’ money (large corporates and FDI) in the retail sector would in the long run not harm interests of small, traditional retailers. 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 (kiryana and other small time retailing shops) have undoubtedly failed to provide to the masses employed in them.

Conclusively we can say that FDI in retail will prove to be a boon for the Indian economy. The fears of small i.e. fringe shopkeepers getting displaced are vastly exaggerated. When domestic majors were allowed to invest in retail, both supermarket chains and neighborhood pop-and-mom stores coexisted. India Inc. hailed the government’s decision to implement FDI in multi brand retail and voiced that it will give a strong message to investors that the government means business and stands firm on its initiatives. This decision is a right step and will go a long way in capital infusion and is expected to strengthen the farmer’s community. If anything, the entry of retail big boys is likely to hot up competition, giving consumers a better deal, both in prices and choices. Mega retail chains need to keep price points low and attractive because that’s the USP of their business. This is done by smart procurement, better inventory management& operationalizing using the product company’s money, excellent business practices from which Indian retail sector can also learn. The argument that farmers will suffer once global retail has developed a virtual monopoly is also weak. To begin with, it’s very unlikely that global retail will ever become monopolies. Stores like Wal-Mart or Tesco are by definition few, on the outskirts of cities (to keep real estate costs low), and can’t intrude into the territory of local kiryana stores. So, they cannot eat up their share of pie. Secondly, it can’t be anyone’s case that farmers are getting a good deal right now. The fact is that farmers barely subsist while middlemen take the cream and if we still do, we are getting dreamy about this unequal relationship.

[notice_box]The views represented in this blog are those of the author. It does not represent the thoughts, intentions or plans of the Swaniti Initiative.[/notice_box]