Last evening, the Union Cabinet cleared a long-awaited, much-debated and potentially transformational reform proposal that promises to revolutionise an industry that is estimated to be nearly a trillion dollar in size. As expected, the move has evoked very strong (and mixed) reactions from various political parties, various segments of industry and indeed, from members of the general public as well. While this is a very defining and heady moment for Indian FDI policy – it has taken two whole decades since India began its economic liberalisation initiative in 1991 for the policy on FDI in retail to reach the current status – the bacon is not quite home yet, as the government would now have to get the political buy-in for this significant reform from other political parties who have expressed opposition or reservations about the same. Nonetheless, there is an air of exuberance and immediacy about the whole thing, as the Winter Session of Parliament is currently on, and there is a general expectation (hope?) that the government will manage to secure the political buy-in required to push ahead with this potentially game-changing reform.
Much has been written and said about the economic and social pros and cons of opening up multi-brand retail to foreign investment and of enhancing the FDI limits in single-brand retail to 100 per cent. The key arguments centre around the potential impact that FDI in retail might have on jobs, small-to-medium-scale entrepreneurship, supply chain logistics, fairer selling power to farmers, food and essential goods inflation, etc. There are several economic and legal benefits to the Indian market from allowing FDI in multi-brand retail and in further liberalising FDI in single-brand retail, some of which are detailed below:
Legally blessed market access: First and foremost, this move will take away a long-standing regulatory market access barrier and will bring in parity between Indian and foreign retailers. It means there would be no further need for complex (and operationally difficult) structuring of foreign investment indirectly into Indian retail. The complexity and regulatory uncertainty attached to such structures have kept many foreign retail players out of the Indian market but now, several more reputable names from overseas markets will seriously consider entering the Indian market. The existing players who have already entered the Indian market through ‘back-end-only’ models will now welcome this move, as this would enable them to move their Indian plans to a more straightforward and transparent model. This would also be very exciting news for the single-brand retailers as they would be able to formulate and implement a focused strategy for India, knowing that they have the ability to own and control 100 per cent of their Indian operations without being saddled with an Indian partner whose capital constraints could impede the foreign player’s growth plans.
Further, by removing this rather significant market access barrier, India will be sending out a rather strong and broader-level positive signal to the global business community about India’s continued commitment to market reform and to providing a free and market-driven regulatory platform to global businesses, thereby bolstering global investor confidence in the Indian market.
New avenues for fundraising: For Indian companies who are in the organised retail sector or who have plans to enter the organised retail sector, this is, indeed, a very welcome move as it opens up a whole new universe of fundraising options. Indian companies may partner with international retail players and thus garner both funding, as well as operational best practices, or they can just choose to raise funding from foreign private equity funds. Given that much of the PE money that flows into India today is foreign money, this move opens up huge possibilities for the growth of India’s organised retail sector, thereby significantly enhancing the competitiveness of the industry.
Domino benefits: The move to open up the retail sector is not only going to result in growth of the retail industry for the above-named reasons, but is also likely to give a major fillip to other related industries like real estate, construction, logistics, agriculture and agro products, etc., whose fortunes are closely linked to those of the retail sector. This will naturally result in creation of jobs and enhancement of the standard of living in Tier II and Tier III cities. Of course, arguably, some of these domino benefits may also result in creation of some harmful side-effects like price rise, unaffordable housing, etc., which again can be dealt with through appropriate regulations and market corrections.
So, is it time to pop the corks yet? Perhaps. But having been a transactional lawyer working through the various phases of economic reform in India since the early days of liberalisation, I am inclined to temper the jubilation with some degree of caution. I say this because, as with many other instances of reform, much of the devil will really lie in the detail. One will have to study the language of the final regulations that will be announced in this regard to evaluate how much cause to cheer there really is going to be. Very often, what is meant to be commendable reform can get caught in the quagmire of vague regulatory language, harsh and impractical restrictions and so on. I raise below some of the key issues that will need to be addressed with clarity by the government in the regulations to be announced in this regard, so that the true benefits of this game-changing policy reform can be realised:
Minimum investment amount: The proposal is to permit FDI in retail only if the foreign investor brings in a minimum investment of $100 million. While I think that this is not, per se, an unreasonable concept, there are a couple of important issues I would like to raise in this regard.
First, with respect to investments by strategic players (foreign retail business operators), while the $100 million floor is not unreasonable as it ensures only serious players enter the market, it may not be reasonable to expect the entire $100 million to be brought up front. What may be more rational is to permit foreign investors to bring in the minimum $100 million investment over a period of, say, 2-3 years. Further, one hopes that there would be no proposals for any ‘lock-in’ of this investment amount, as was imposed with respect to FDI in real estate (with disastrous results). Any such unreasonable condition (which doesn’t even serve any meaningful purpose in the larger scheme of things) is likely to cause discomfort and confusion amongst investors.
Secondly, I think a minimum investment amount of $100 million could be a major deterrent for many private equity investors. If one looks at PE deal data in India over the past 5-6 years, one would find that there have been usually less than 10 deals a year which are valued at more than $100 million. Most PE deals in India tend to be growth equity deals in the $25 million-$50 million range and in the light of this, I would argue that the floor should be much lower for PE investors – say, around $25 million or so. This would ensure that Indian companies can actually benefit from this move as they are more likely to attract private equity interest with a lower threshold amount.
Geographic/demographic restrictions: The reform move also proposes certain geographic and demographic conditions to be complied with by foreign investors investing in the Indian retail sector. There is a requirement that at least 50 per cent of the investment should go into rural locations and that at least 30 per cent of the input should be sourced from SMEs. These could have a challenging impact, potentially on the sourcing strategies of foreign-owned retail businesses, thereby mitigating operational flexibility. Further, there is a limitation that foreign-owned retail businesses can be set up only in cities with a minimum population of 1 million. Given that only a handful of Indian cities meet this requirement, the benefits of modern retailing practices would continue to be unavailable to a large swathe of the Indian population.
State government intervention: There is also a proposal for letting state governments have a say on whether foreign-owned retail businesses should be allowed to set up operations in their states or not, on the ground that “trade and commerce within the state” is a matter reserved for the state to legislate on. This could be a bit of a worrying proposition for foreign retailers. While in a good scenario, states may healthily compete with one another to attract more retail businesses, given that several states have a history of poor governance and lack of political stability, this could cause anxiety and concern among foreign retailers about the possible risk of state government intervention, thereby impeding the implementation of nation-wide sourcing and distribution strategies.
All in all, I take an optimistic view of this development, which has been long overdue. But for our country to truly derive the benefits of this policy reform, some of the above legal issues would have to be addressed. One hopes that the final language of the regulations, after the process of parliamentary debate, does not introduce confusing or retrograde conditionalities which could restrict the true potential of this very significant reform move.