In September last year, when the Indian government allowed foreign direct investment (FDI) up to a level of 51% in multi-brand retail, it was expected that global players like Walmart, Tesco and Carrefour would move quickly. But the government has not received a single application until now. Onerous conditions and lack of clarity in the policy have been a big damper.
Key conditions in the initial policy guidelines include a minimum investment of US$100 million, of which 50% needs to be in back-end infrastructure; 30% of products must be sourced from small enterprises; and retail outlets can be set up only in cities with a population of over one million.
“We are waiting for greater clarity,” Tesco’s chief executive Philip Clarke told the media a few weeks ago after a meeting with the federal commerce and industry minister.
But recent clarifications from the department of industrial policy and promotion (DIPP) may only slow down the process further. The US$100 million investment requirement is a case in point. The government has now said that acquisition of existing retail stores will not be considered part of this mandatory investment. Global retailers will have to set up new front-end operations. The US$50 million mandated for back-end operations also has to be in creating greenfield infrastructure. The 30% products sourced from small industries cannot be used for global business, and fresh products do not fall under the ambit of the 30% sourcing. There are additional qualifying clauses, too.
“The spirit of the government announcement seems to be that there is no easy way to invest in retail in India. It is now clear that foreign players will have to create capacities from scratch. This means that they will need to go back to the drawing board, assess their appetite for investment and rethink their strategies,” says Ankur Bisen, vice president – retail, at New Delhi-based research and consultancy firm Technopak Advisors. Bisen feels that the new set of clarifications has “added more rigidity and disincentives and will result in further delay in investment decisions.”
Entrepreneur Meena Ganesh sees the clarifications as a “mixed bag.” Ganesh, who was earlier heading Tesco’s operations in India, says: “On the positive side, it is good to see the government clarifying key aspects and [removing] ambiguities …. It is also great to see that the government realizes and understands the need to create a strong back-end and supply chain network. On the negative side, this is disappointing since more restrictions and more rules will delay and dampen the interest of foreign firms. K. Ganesh, serial entrepreneur with strong experience in starting businesses in India, adds: “Not allowing the M&A route defeats logic, especially given the bureaucracy and startup hurdles in India. The make-or-buy decision or organic-versus-inorganic decision, especially in early stages, is a commercial one.”
Consider Walmart. It entered India in 2007 in a wholesale cash-and-carry format in partnership with Bharti Enterprises. Wal-Mart expected that once FDI in multi-brand retail was allowed, this relationship would enable it to get a head start over other international retailers looking to establish a presence in India.
But Walmart has been embroiled in a series of controversies in the country. These include charges of violations of the Foreign Exchange Management Act and FDI regulations, and lobbying for FDI in multi-brand retail. (In India, lobbying is an illegal activity.) While the probe against lobbying has apparently been closed for lack of conclusive evidence, the company is still under scrutiny on other fronts.
In 2010 — prior to the opening up of FDI in multi-brand retail — Walmart made investments in Cedar Support Service, the holding company of Bharti Retail which has over 200 Easy Day stores in the country. A recent Walmart India statement regarding this says: “We are in compliance with India’s FDI guidelines. All procedures and processes have been duly followed and details filed with relevant Indian government authorities, including the Reserve Bank of India.” Responding to a query by India Knowledge at Wharton on Walmart’s investment in Cedar, a Bharti Group spokesperson said: “We are in complete compliance of all regulations and will continue to do so.”
Walmart’s investments in Cedar in 2010 were by way of compulsory convertible debentures (CCDs). According to media reports, Walmart is now looking to convert the CCDs into equity and thereby get a 49% stake in Cedar. But, with the government mandating that all front-end investments have to be in greenfield ventures, Walmart may well have to rethink this move.
The company has another issue to worry about. Currently, the Bharti Walmart cash-and-carry stores reportedly sell 85% of their products to Bharti Retail’s Easy Day stores. According to DIPP clarifications, Bharti Walmart will have to restrict its sales to Easy Day to 25% of its turnover. Or, it will need to reorganize its corporate structure. “I don’t see the logic in this. A lot more clarity is required on this front,” says Bisen.
In a conversation with India Knowledge at Wharton in September 2011, Raj Jain, president of Walmart India and managing director and CEO of Bharti Walmart had said, “If FDI does not open in the next three years or so, then that may require a rethink on the whole strategy, because … you can’t monetize all your investments just on cash-and-carry.” Now, Walmart’s rethink on strategy may have to come thanks to the fine print in India’s FDI policy.
Indian retail chains that were looking to dilute their stake to the multinationals will also need to go back to the drawing board. “They will now find it difficult to attract foreign retailers. This will be a big jolt to them.” says Bisen. Adds Ganesh: “This seems to favor the very large industrial houses … as they can fund their ventures all the way through to an IPO. It will give them a competitive advantage as it will restrict the number of players. Any such scenario is not good for free markets and the consumer.”
S. Ramesh Kumar, professor of marketing at the Indian Institute of Management Bangalore (IIMB), offers another perspective. Pointing out that India is “a unique market with a large chunk of retailing happening in the unorganized sector across several categories,” Kumar says: “With modern retail registering considerable growth in recent times, the government’s clarification [on FDI in multi-brand retail] is perhaps a relief for the unorganized market.”
According to Kumar, without the stringent clarifications announced by the government, multi-brand FDI retailers might have brought “several value-based offerings at the lower end of the market.” He suggests that “while consumer groups may benefit out of these offerings, the unorganized sector, both retailers and local brands … would be significantly affected.” Kumar adds: “The condition regarding the creation of back-end infrastructure by the multi-brand [global retailers] can contribute to the professional and gradual development of suppliers. Since this would be gradual, the unorganized sector, too, will have time to adapt.”