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Foreign Direct Investment in Indian Retail Sector – An Analysis

 

Dr. A. Vinaygamoorthy

Associate Professor, Department of Commerce, Periyar University, Salem - 636 011

 

and

 

Mr. C. Sankar

Ph.D., Research Scholar, Department of Commerce, Periyar University, Salem - 636 011

 

Abstract

 

            FDI is a tool for economic growth through its strengthening of domestic capital, productivity and employment. FDI also plays a vital role in the up gradation of technology, skills and managerial capabilities in various sectors of the economy. The present paper attempts to analyze significance of the FDI Inflows in Indian retail sector since 1991 and relating the growth of retail sector FDI in generation of employment in terms of skilled and unskilled. Supporters of FDI in retail trade talk of how ultimately the consumer is benefited by both price reductions and improved selection, brought about by the technology and know-how of foreign players in the market. This in turn can lead to greater output and domestic consumption.

 

Introduction  

           

            The retail industry in India is of late often being hailed as one of the sunrise sectors in the economy. AT Kearney, the well-known international management consultancy, recently identified India as the ‘second most attractive retail destination’ globally from among thirty emergent markets. It has made India the cause of a good deal of excitement and the cynosure of many foreign eyes. With a contribution of 14% to the national GDP and employing 7% of the total workforce (only agriculture employs more) in the country, the retail industry is definitely one of the pillars of the Indian economy.

 

          Retailing is the interface between the producer and the individual consumer buying for personal consumption. This excludes direct interface between the manufacturer and institutional buyers such as the government and other bulk customers. A retailer is one who stocks the producer’s goods and is involved in the act of selling it to the individual consumer, at a margin of profit. As such, retailing is the last link that connects the individual consumer with the manufacturing and distribution chain.

 

Foreign Direct Investment (FDI) in Retail:

 

            Given this backdrop, the recent clamour about opening up the retail sector to Foreign Direct Investment (FDI) becomes a very sensitive issue, with arguments to support both sides of the debate. It is widely acknowledged that FDI can have some positive results on the economy, triggering a series of reactions that in the long run can lead to greater efficiency and improvement of living standards, apart from greater integration into the global economy. Supporters of FDI in retail trade talk of how ultimately the consumer is benefited by both price reductions and improved selection, brought about by the technology and know-how of foreign players in the market. This in turn can lead to greater output and domestic consumption.

 

            But the most important factor against FDI driven “modern retailing” is that it is labour displacing to the extent that it can only expand by destroying the traditional retail sector. Till such time we are in a position to create jobs on a large scale in manufacturing, it would make eminent sense that any policy that results in the elimination of jobs in the unorganized retail sector should be kept on hold.

 

            Though most of the high decibel arguments in favour of FDI in the retail sector are not without some merit, it is not fully applicable to the retailing sector in India, or at least, not yet. This is because the primary task of government in India is still to provide livelihoods and not create so called efficiencies of scale by creating redundancies. As per present regulations, no FDI is permitted in retail trade in India. Allowing 49% or 26% FDI (which have been the proposed figures till date) will have immediate and dire consequences. Entry of foreign players now will most definitely disrupt the current balance of the economy, will render millions of small retailers jobless by closing the small slit of opportunity available to them.

 

            Imagine if Wal-Mart, the world’s biggest retailer sets up operations in India at prime  locations in the 35 large cities and towns that house more than 1million people. The supermarket will typically sell everything, from vegetables to the latest electronic gadgets, at extremely low prices that will most likely undercut those in nearby local stores selling similar goods. Wal- Mart would be more likely to source its raw materials from abroad, and procure goods like vegetables and fruits directly from farmers at preordained quantities and specifications. This means a foreign company will buy big from India and abroad and be able to sell low – severely undercutting the small retailers. Once a monopoly situation is created this will then turn into buying low and selling high.

 

            Such re-orientation of sourcing of materials will completely disintegrate the already established supply chain. In time, the neighbouring traditional outlets are also likely to fold and perish, given the ‘predatory’ pricing power that a foreign player is able to exert. As Nick Robbins wrote in the context of the East India Company, “By controlling both ends of the chain, the company could buy cheap and sell dear”14. The producers and traders at the lowest level of operations will never find place in this sector, which would now have demand mostly only for fluent English-speaking helpers. Having been uprooted from their traditional form of business, these persons are unlikely to be suitable for other areas of work either.

 

            It is easy to visualize from the discussion above, how the entry of just one big retailer is capable of destroying a whole local economy and send it hurtling down a spiral. One must also not forget how countries like China, Malaysia and Thailand, who opened their retail sector to FDI in the recent past, have been forced to enact new laws to check the prolific expansion of the new foreign malls and hypermarkets.

 

            Given their economies of scale and huge resources, a big domestic retailer or any new foreign player will be able to provide their merchandise at cheaper rates than a smaller retailer. But stopping an Indian retailer from growing bigger is something current public policy cannot do, whereas the State does have the prerogative in whether foreign entry in the retail sector should be stalled or not.

 

            It is true that it is in the consumer’s best interest to obtain his goods and retails at the lowest possible price. But this is a privilege for the individual consumer and it cannot, in any circumstance, override the responsibility of any society to provide economic security for its population. Clearly collective well-being must take precedence over individual benefits.

 

Strategic Issues Concerning Retail Sector in India

 

            Retailing is the largest private industry in India and second largest employer after agriculture. The sector contributes to around 10 percent of GDP. With over 12 million retail outlets, India has the highest retail outlets density in the world. This sector witnessed significant development in the past 10 years from small unorganized family owned retail formats to organized retailing. Liberalization of the economy, rise in per capita income and growing consumerism has encouraged large business and venture capitalist in investing in retail infrastructure. The importance of retail sector in India can be judged from following facts (a) Retail sector is the largest contributor to the Indian GDP (b) The retail sector provides 15% employment (c) India has world largest retail network with 12 million outlets (d) Total market size of retailing in India is U.S $ 180 billion (e) Current share of organized retailing is just 2% which comes around to $3.6 trillion (f) organized retail sector is growing @ 28% per annum.

 

            The Indian retail sector is very different from that of the developed countries. In the developed countries, products and retails normally reach consumers from the manufacturer/producers through two different channels: (a) via independent retailers (‘vertical separation’) and (b) directly from the producer (‘vertical integration’). In the latter case, the producers establish their own chains of retail outlets, or develop franchises. On the other hand, Indian retail industry is divided into organised and unorganised sectors. Organised retailing refers to trading activities undertaken by licensed retailers, that is, those who are registered for sales tax, income tax, etc. These include the corporate-backed supermarkets and retail chains, and also the privately owned giant retail businesses. Unorganized retailing is by far the prevalent form of trade in India – constituting 98% of total trade, while organized trade accounts only for the remaining 2% – and this is projected to increase to 15-20 per cent by 2010. Nonetheless the organized sector is expected to grow faster than GDP growth in next few years driven by favorable demographic patterns, changing lifestyles, and strong income growth.

 

Growth drivers in India for retail sector

 

            The retail industry in India is currently growing at a great pace and is expected to go up to US$ 833 billion by the year 2013. It is further expected to reach US$ 1.3 trillion by the year 2018 at a CAGR of 10%. As the country has got a high growth rate, the consumer spending has also gone up and is also expected to go up further in the future. In the last four years, the consumer spending in India climbed up to 75%. As a result, the Indian retail industry is expected to grow further in the future days. By the year 2013, the organized sector is also expected to grow at a CAGR of 40%. The key factors that drive growth in retail industry are young demographic profile, increasing consumer aspirations, growing middle class incomes and improving demand from rural markets. Also, rising incomes and improvements in infrastructure are enlarging consumer markets and accelerating the convergence of consumer tastes. Liberalization of the Indian economy, increase in spending percapita income and the advent of dual income families also help in the growth of retail sector. Moreover, consumer preference for shopping in new environs, availability of quality real estate and mall management practices and a shift in consumer demand to foreign brands like McDonalds, Sony, Panasonic, etc. also contributes to the spiral of growth in this sector. Furthermore, the Internet revolution is making the Indian consumer more accessible to the growing influences of domestic and foreign retail chains. Reach of satellite T.V. channels is helping in creating awareness about global products for local markets. About 47% of India's population is under the age of 20; and this will increase to 55% by 2015. This young population, which is technology-savvy, watch more than 50 TV satellite channels, and display the highest propensity to spend, will immensely contribute to the growth of the retail sector in the country. Moreover, the retail sector also acts as an important employment absorber for the present social system. Thus, when a factory shuts down rendering workers jobless; or peasants find themselves idle during part of the year or get evicted from their land; or the stagnant manufacturing sector fails to absorb the fresh entrants into the job market, the retail sector absorbs them all.

 

Challenges of Retailing in India

 

            In India the retailing industry has a long way to go and to become a truly flourishing industry, retailing needs to cross various hurdles. The first challenge facing the organized retail sector is the competition from unorganized sector. Needless to say, the Indian retail sector is overwhelmingly swarmed by the unorganized retailing with the dominance of small and medium enterprises in contradiction to the presence of few giant corporate retailing outlets. The trading sector is also highly fragmented, with a large number of intermediaries who operate at a strictly local level and there is no ‘barrier to entry’, given the structure and scale of these operations.

 

            The tax structure in India favors small retail business. Organized retail sector has to pay huge taxes, which is negligible for small retail business. Thus, the cost of business operations is very high in India. Developed supply chain and integrated IT management is absent in retail sector. This lack of adequate infrastructure facilities, lack of trained work force and low skill level for retailing management further makes the sector quite complex. Also, the intrinsic complexity of retailing- rapid price changes, threat of product obsolescence, low margins, high cost of real estate and dissimilarity in consumer groups are the other challenges that the retail sector in India is facing.

 

            The status of the retail industry will depend mostly on external factors like Government regulations and policies and real estate prices, besides the activities of retailers and demands of the customers also show impact on retail industry. Even though economy across the globe is slowly emerging from recession, tough times lie ahead for the retail industry as consumer spending still has not seen a consistent increase. In fact, consumer spending could contract further as banks have been overcautious in lending. Thus, retailers are witnessing an uphill task in terms of wooing consumers, despite offering big discounts. Additionally, organized stores, especially in the food and grocery segment. In retail sector, Automatic approval is not allowed for foreign investment. There are restrictions on Foreign Direct Investment imposed in order to protect the interests of the country and also in order to allow the domestic companies to make more profits with less competition than that of in the presence of rival international firms. The retail trading in India constitutes as one of those few sectors where FDI is not freely and healthily allowed. All of these retailers, therefore, to make their presence felt in the country, have either tied-up or trying to tie-up with local corporate, to offer their retails for back-end operations like sourcing, logistics, inventory management, among others, for front-end, multi-brand retail operations of such corporate. While in some sectors the restrictions imposed by the government are comprehensible; the restrictions imposed in few others, including the retail sector, are utterly baseless and are acting as shackles in the progressive development of that particular sector and eventually the overall development of the Indian Inc. The scenario is kind of depressing and unappealing, since despite the ongoing wave of incessant liberalization and globalization, the Indian retail sector is still aloof from progressive and ostentatious development. This dismal situation of the retail sector undoubtedly stems from the absence of an FDI encouraging policy in the Indian retail sector.

 

Recommendations

 

1. The retail sector in India is severely constrained by limited availability of bank finance. The Government and RBI need to evolve suitable lending policies that will enable retailers in the organized and unorganized sectors to expand and improve efficiencies. Policies that encourage unorganized sector retailers to migrate to the organized sector by investing in space and equipment should be encouraged.

2. A National Commission must be established to study the problems of the retail sector and to evolve policies that will enable it to cope with FDI – as and when it comes.

3. The proposed National Commission should evolve a clear set of conditionalities on giant foreign retailers on the procurement of farm produce, domestically manufactured merchandise and imported goods. These conditionalities must be aimed at encouraging the purchase of goods in the domestic market, state the minimum space, size and specify details like, construction and storage standards, the ratio of floor space to parking space etc. Giant shopping centres must not add to our existing urban snarl.

4. Entry of foreign players must be gradual and with social safeguards so that the effects of the labour dislocation can be analysed & policy finetuned. Initially allow them to set up supermarkets only in metros. Make the costs of entry high and according to specific norms and regulations so that the retailer cannot immediately indulge in ‘predatory’ pricing.

5. In order to address the dislocation issue, it becomes imperative to develop and improve the manufacturing sector in India. If this sector is given due attention, and allowed to take wings, then it could be a source of great compensation to the displaced workforce from the retail industry.

6. The government must actively encourage setting up of co-operative stores to procure and stock their consumer goods and commodities from small producers. This will address the dual problem of limited promotion and marketing ability, as well as market penetration for the retailer. The government can also facilitate the setting up of warehousing units and cold chains, thereby lowering the capital costs for the small retailers.

7. This is more than just a sizeable portion of the pie and what makes it even more significant is the fact that in this segment, returns are likely to be much higher for any retailer. Prices for perishable goods like vegetables, fruits, etc. are not fixed (as opposed to, say, branded textiles) and therefore, this is where economies of scale are likely to kick in and benefit the consumer in the form of lower prices. But due attention must be given to the producer too. Often the producer loses out, for example, when the goods are procured at Rs.2 and ultimately sold to the consumer at about Rs.15 as in the case of tomatoes now. The Government themselves can tap into the opportunities of this segment, rather than letting it be lost to foreign players. And by doing so, they can more directly ensure the welfare of producers and the interest of the consumers.

8. Set up an Agricultural Perishable Produce Commission (APPC), to ensure that procurement prices for perishable commodities are fair to farmers and that they are not distorted with relation to market prices.

 

Limitations of the Present Setup

 

            There has been a lack of investment in the logistics of the retail chain, leading to an inefficient market mechanism. Though India is the second largest producer of fruits and vegetables (about 180 million MT), it has a very limited integrated cold-chain infrastructure, with only 5386 stand-alone cold storages, having a total capacity of 23.6 million MT. ,80% of this is used only for potatoes. The chain is highly fragmented and hence, perishable horticultural commodities find it difficult to link to distant markets, including overseas markets, round the year. Storage infrastructure is necessary for carrying over the agricultural produce from production periods to the rest of the year and to prevent distress sales. Lack of adequate storage facilities cause heavy losses to farmers in terms of wastage in quality and quantity of produce in general, and of fruits and vegetables in particular. Post-harvest losses of farm produce, especially of fruits, vegetables and other perishables, have been estimated to be over Rs. 1 trillion per annum, 57 per cent of which is due to avoidable wastage and the rest due to avoidable costs of storage and commissions''. As per some industry estimates, 25-30% of fruits and vegetables and 5-7% of food grains in India are wasted 10. Though FDI is permitted in cold-chain to the extent of 100%, through the automatic route, in the absence of FDI in retailing; FDI flow to the sector has not been significant.

 

             Intermediaries dominate the value chain. They often flout mandi norms and their pricing lacks transparency. Wholesale regulated markets, governed by State APMCActs, have developed a monopolistic and non-transparent character. According to some reports, Indian farmers realize only 1/ 3rd of the total price paid by the final consumer, as against 2/ 3rd by farmers in nations with a higher share of organized retail!". A study commissioned by the World Bank attributes the export non-competitiveness of India's horticulture produce to its weak supply chain. The study shows that the average price that the farmer receives for a typical horticulture product is only 12-15 per cent of the price the consumer pays at a retail outlet.

 

             There is a big question mark on the efficacy of the public procurement and PDS set-up and the bill on food subsidies is rising. In spite of such heavy subsidies, overall food based inflation has been a matter of great concern. The absence of a 'farm-to-fork' retail supply system has led to the ultimate customers paying a premium for shortages and a charge for wastages.

 

Conclusion

 

            Opening up of FDI in multi-brand retail in India could potentially be a mixed blessing for domestic players. While initially the small indigenous retailers’ business would be impacted once modern retail enters the locality, this adverse impact is expected to be short-lived and to weaken over time. While this long awaited move is not expected to have an immediate impact on the Indian retail sector, it is expected to reap benefits in the medium to long-term as it will help improve the A) balance sheet and liquidity profile of cash-starved retailers with aggressive expansion plans B) supply chain and back-end infrastructure while reducing margins for middlemen through direct sourcing from farmers and C) arrest inflationary pressures through increased supplies facilitated by improved productivity of farmers and reduction of agri-waste. However, once 100% FDI is allowed in retail, that is when the landscape will become extremely competitive. Further, the move needs to be monitored in the wake of the current opposition by several political parties.

 

Reference and Notes

 

  1. Narula, Rajneesh (Ed.), Trade and Investment in a Globalising World, Series in International Business and Economics, Elsevier Science Ltd., 2001.
  2. Oberai.A.S and Chadha.G.K (Ed.), Job Creation in Urban Informal Sector in India: Issues and Policy Options, International Labour Organisation, 2001.
  3. Raipuria, Kalyan, What Size the ‘New’ Economy? A Conduit Approach, Economic and Political Weekly, vol 37,pp 1062-1067, March 2002.
  4. Saggi, Kamal, Trade, Foreign Direct Investment, and International Technology Transfer: A Survey, The World Bank Research Observer, vol 17, no. 2, pp 191-235, Fall 2002.
  5. Mrs. Jayashree patil-dake, ‘analysis of fdi inflows in india” volume no: 2 (2011), issue no. 1 (january)
  6. Misra, S.K. (2000). Indian Economy, Himalaya Publishing House, 18th Edition, p. 739 New Delhi
  7. Assaf Razin & Efraim Sadka (2007). Foreign Direct Investment, Analysis of Aggregate Flows Princeton University Press, U.S.A.
  8. http://www.sebi.gov.in/Index.jsp?contentDisp=FIITrends
  9. http://www.sethassociates.com/policy_on_foreign_direct_investment
  10. http://planningcommission.gov.in/
  11. http://finmin.nic.in/capital_market/capital_market.asp
  12. http://business.mapsofindia.com/india-gdp/sectorwise/retails-sector growth-rate.html
  13. http://www.randstad.com/the-world-of-work/employment-rises-in-indias-retail-sector?c=4374
  14. www.indiabudget.nic.in
  15. www.indiaonestop.com/economy-macro-issues.htm
  16. http://planningcommission.nic.in/data/datatable/Data0910/tab32.pdf
  17. http://dipp.nic.in/fdi_statistics/india_fdi_index.htm
  18. http://www.startbizindia.in/india_fdi_trend.php