Foreign Direct Investment in Multi Brand Retail Trading- Some Basics

When the so called ‘big bang’ reforms were announced by the Government of India the term Foreign Direct Investment (FDI) gained prominence. The fact that these announcements were only minor steps to reverse the perceptions and nothing earth shattering was lost in the propaganda blitzkrieg that followed!

What caught the imagination of politicians as well as common people was the 51% FDI allowed into multi-brand retail trade.  This was projected as something that will eliminate the entire neighbourhood (kirana) shops and also the very livelihood of entire Indians.  Both Left and the Right wings of economic divide are planning to force those very same Kirana shops to remain closed on a Bharat Bandh, to protest the entry of FDI into the sector!

The debate that followed brought out the fact that, like any other major decisions in India, even this was being seen only through politically coloured eyes.  Many of the arguments did not show even a basic understanding of the related concepts.  Let us look at some of the basic of the FDI and its impact in the multi-brand retail trade sector.

Legal framework

The power to regulate FDI is derived from the powers granted to the Government under the Foreign Exchange Management Act, 1999, to regulate in flow and out flow of foreign exchange.  Under these powers GoI can prescribe conditions for entry of foreign capital into any of the sectors.  These conditions or framework comes under the category of subordinate legislation promulgated through Cabinet or Ministerial decisions under the delegated powers, in the main Act.  Therefore, a Government need not seek Parliament’s approval for making any changes in such frameworks.

In order to ensure that the policy framework on FDI is made ‘transparent, predictable and easily comprehensible’ for all the potential foreign investors and the Indian parties who want to receive such investments, the Department of Industry Policy and Promotion, under the Ministry of Commerce and Industry of Govt of India, publishes a consolidated FDI Policy.  This policy document is updated every year, with changes, if any, issued during the preceding year.

Foreign Investment

Inflow of foreign capital happens through many modes of which the following are important:

Foreign Direct Investments	For Persons resident outside India
Foreign Portfolio Investments	For foreign institutional investors (FIIs), Non Resident Indians (NRIs) and Persons of Indian Origin (PIOs)
Foreign Venture Capital Investments	For Foreign Venture Capital Institutions through Venture Capital Funds or Indian venture capital Undertakings
Other Investments (G0Sec, NCD etc)	For FIIS , NRIs and PIOs
Investments on non-repatriable basis (cannot be taken back from India)	For NRIs and PIOs
Issue of shares by Indian Companies under FCCB/ADR/GDR	For Persons resident outside India
FDI in Limited Liability Partnerships	For Persons resident outside India , subject to prescribed additional conditions for LLPs
External Commercial Borrowings (ECB)	For International lenders , subject to extant RBI regulations on ECBs

Source: http://rbidocs.rbi.org.in/rdocs/notification/PDFs/15MFI300611F.pdf (with modification)

What is FDI and Why FDI?

While we saw that there are many modes for entry of foreign capital, here let us restrict ourselves to the FDI alone.  FDI means direct equity investment into a domestic company with the objective profit earning/sharing, with or without acquiring management control.  FDI is distinct from External Commercial Borrowing (ECB). ECB is debt funding sourced from foreign lenders and is required to be repaid with interest.  However, in FDI there is no obligation to repay.  Only the profit is shared by way of dividends and the exit is only by way of selling the equity shares to any third party or the Indian partners.

After the opening up of Indian economy as part of the Liberalisation and Globalisation, it is now the stated objective of Govt of India to attract and promote FDI in order to ‘supplement domestic capital, technology and skills, for accelerated economic growth’.   It is widely accepted that the capital required for growth of Indian economy to meet the aspirations of its growing population is just not available domestically (even if you point out those presumptive zeros of CAG to counter this, please note that even those zeros will have to come from somewhere!).

FDI is preferred to Portfolio investments for the simple reason that unlike portfolio investments, FDI establishes a lasting interest in the recipient enterprise and therefore greater stability to foreign exchange reserves.  Portfolio investments get invested in listed shares through stock exchanges and are likely to flow out as soon as markets show any downward trends.  But for FDI, to make an exit, it takes much more time and efforts and even the valuation at which domestic investors can buy out the foreign investors is regulated by the Reserve Bank of India.  Hence, FDI investors have much more stake in making the Indian enterprise a success by providing it all the necessary managerial and technical support.

Prohibition of FDI in some sectors

Foreign investment in any form is prohibited in a company or a partnership firm or a proprietary concern or any entity, whether incorporated or not (such as, Trusts) which is engaged or proposes to engage in the following activities:

•  Business of chit fund, or
• Nidhi company, or
• Agricultural or plantation activities, or
• Real estate business, or construction of farm houses, or 
• Trading in Transferable Development Rights (TDRs)

 Apart from the above general prohibitions on Foreign Investment in any form, FDI is also specifically prohibited in certain sectors such as: 

• Atomic Energy
• Lottery Business including Government / private lottery, online lotteries, etc. 
• Gambling and Betting including casinos, etc
• Business of chit fund
• Nidhi company    
• Trading in Transferable Development Rights (TDRs) 
• Activities / sectors not opened to private sector investment
• Agriculture (excluding Floriculture, Horticulture, Development of  seeds, Animal Husbandry, Pisciculture and cultivation of vegetables, mushrooms, etc. under controlled conditions and services related to agro and allied sectors) and Plantations (other than Tea Plantations)
• Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes              

Till the recent decision announced by the Govt, Multi Brand Retail Trading (except single brand product retailing) was also a part of the above list.  In short it is the removal of MBRT from the above list of prohibited sectors that has caused all the commotion.

Restriction on FDI in some sectors

Further, the Govt has also prescribed conditions on FDI into certain sectors.  They are listed in the table provided in the consolidated FDI Policy (pages from 42 to 78).  The entries in the Table may permit FDI in a specific sector under the automatic route or under the approval route where prior sanction from the Government (FIPB) will have to be obtained.

In sectors/activities not listed in this Table, FDI is permitted up to 100% on the automatic route, subject to applicable laws and regulations, if any, and security and other conditions that may be prescribed from time to time.  The Retail Trading will now become another entry in this Table with FDI Cap/Equity of 51%.

Implications of FDI in Retail Trading                

Many a commentators has opined that the permitted 51% FDI into retail trading will sound the death knell for crores of retail traders or the kirana shops in India. But how far is it true?  One look at the safeguards will clearly tell us that it is a very humble beginning into organised retail trading with hardly any potential to threaten existing retail traders!

The following safe guards are being incorporated in the policy in order to provide a level playing field to existing traders: 

• FDI capped at 51%
• Retail sales outlets may be set up only in those States which have agreed or agree in future to allow FDI in Multi Brand Retail Trade.
• Retail sales locations may be set up only in cities with a population of more than 10 lakh (As per 2011 census, there are only 53 such cities whereas there are 7935 towns and cities in India)
• In States/ Union Territories not having cities with population of more than 10 lakh as per 2011 Census, retail sales outlets may be set up in the cities of their choice, preferably the largest city and may also cover an area of 10 kms around the municipal/urban agglomeration limits of such cities.
• Establishment of the retail sales outlets will be in compliance of applicable State laws/ regulations, such as the Shops and Establishments Act etc
• Retail locations will be restricted to conforming areas as per the Master/Zonal Plans of the concerned cities and provision will be made for requisite facilities such as transport connectivity and parking.
• At least 30 per cent of the procurement of manufactured processed products shall be sourced from small industries, in the country, that have total investment in plant and machinery not exceeding $100 million.
• Minimum size of FDI will be $100Million
• At least 50 per cent of the total FDI brought in shall be invested in back-end infrastructure, within three years of induction of FDI. Back end infrastructure includes investment made towards processing, manufacturing, distribution, design improvement, quality control, packaging, logistics, storage, warehouse, agriculture market produce, infrastructure, etc.  Expenditure on land cost and rental, if any, will not be counted for purposes of back-end infrastructure
• A high-level group under the Minister of Consumer Affairs will be constituted to examine various issues concerning internal trade and make recommendations for internal trade reforms.
• A strong legal framework in the form of Competition Commission is available to deal with any anti competitive practices including predatory pricing.

From the above restrictions, it is clear that the proposed investments will be made through Indian companies where at least 49% of the holding will remain with Indian equity holders and the retails outlets by these companies will be set up in very large cities where the growing demands can easily absorb the additional supply outlets. If at all, this will only increase the choice for consumers, thereby forcing the existing kirana shops to innovate and value add to their existing services.  These retail traders will also be benefited by sourcing their goods from the larger chains, thereby eliminating the series of middlemen who do not add any value in the supply chain but cause huge price increase through their commissions. In a growing country like India, there is enough scope for additional investment in these sectors.

In the words of the Govt of India, “The decision would benefit stakeholders across the entire span of the supply chain. Farmers stand to benefit from the significant reduction in post-harvest losses, expected to result from the strengthening of the backend infrastructure and enable the farmers to obtain a remunerative price for their produce. Small manufacturers will benefit from the conditionality requiring at least 30% procurement from Indian small industries, as this would enable them to get integrated with global retail chains. This, in turn, will enhance their capacity to export products from India. As far as small retailers are concerned, it is evident that organized retail already co-exists with small traders and the unorganized retail sector. Studies indicate that there has been a strong competitive response from the traditional retailers to these organized retailers, through improved business practices and technological upgradation. Global experience also indicates that organized and unorganized retail co-exist and grow. The young people joining the workforce will benefit from the creation of employment opportunities. Consumers stand to gain the most, firstly, from the lowering of prices that would result from supply chain efficiencies and secondly, through improvement in product quality, which would come about as a combined result of technological upgradation; efficient grading, sorting and packaging; testing and quality control and product standardization.”

“Implementation of the policy will facilitate greater FDI inflows, additional and quality employment, global best practices and benefit consumers and farmers in the long run, in terms of quality, price, greater supply chain efficiencies in the agricultural sector and development of critical backend infrastructure.”

Conclusion

In India, all the changes are opposed as a rule. We have before us the examples of mindless opposition to the opening up of Indian economy in 1991, introduction of computers, and introduction of VAT etc where the decisions turned out to be the game changers in the positive sense.  Each time we are told that the country’s sovereignty is being surrendered, the country only gains further in its stature and economic power!

The government is well placed to assess the needs for making policy changes.  Let us have faith in them. If they don’t live up to that faith, we have the option to replace them in the next elections.  But to prevent Government from making policies is to hold up the Indian economy and the development of its people.