According to recent reports, India's economy is showing signs of a significant revival. With several economic advantages coming together at a time when investor optimism is high following Narendra Modi's landslide election victory last year, India is now considered to have the best performing economy of the BRICS. In the first edition of India in-depth, our quarterly focus on developments in the Indian business world, we consider doing business in the retail sector – a sector that has long intrigued and appealed to international investors.
In 2012, the Government of India introduced two key reforms aimed at allowing greater foreign direct investment (FDI) into the Indian retail sector. The delineation between single-brand and multi-brand retail, present for many years, was maintained – the former aimed at businesses that sell only their own goods to consumers whilst the latter was effectively concerned with addressing the opening of foreign-owned supermarkets in India. FDI was liberalised in both sub-sectors but to differing degrees. The key policy announcements are summarised below. At the time of writing, these requirements were still in force.
Maximum amount of FDI permitted: 100%
Requirements for FDI up to 51%
To participate via FDI in this sub-sector, foreign companies must adhere to the following:
- products must be sold under a single brand in India as well as internationally;
- products must be branded during manufacturing; and
- the foreign investor must own the brand.
Additional requirement for FDI above 51%
Although the permitted FDI limit was increased from 51% to 100%, an investment of more than 51% FDI triggers the mandatory requirement to source at least 30% of the value of products from Indian cottage industries (businesses that have a total investment in plant and machinery not exceeding USD1 million).
Maximum amount of FDI permitted: 51%
The introduction of foreign owned supermarket chains is politically sensitive and FDI in that sub-sector is far more heavily regulated as a result. FDI of up to 51% comes with the following requirements:
- State government discretion: multi-brand retail outlets can only be set up in those states, which agree to allow it. So far, those are Andhra Pradesh, Assam, Haryana, Himachal Pradesh, Jammu & Kashmir, Karnataka, Maharashtra, Manipur, Rajasthan and Uttarakhand and the Union Territories of Delhi, Daman & Diu and Dadra and Nagar Haveli. At present FDI is therefore permitted in Bangalore, Delhi and Mumbai but not in other key cities such as Chennai or Kolkata.
- Minimum investment: the foreign investor must invest a minimum of USD100 million.
- Minimum extent of investment: at least 50% of the total FDI must be invested in backend infrastructure within three years. "Backend infrastructure" includes capital expenditure on activities such as manufacturing, packaging, logistics, warehousing and distribution but excluding investment in front-end units, land cost and rentals.
- Greenfield investment: investment in backend infrastructure must be in greenfield assets only (i.e. not through acquisition of supply chain/backend assets or stakes from an existing entity; or use of backend facilities of any existing wholesale trading/cash and carry wholesale trading arrangement).
- No franchising: stores must be owned and operated by the entity attracting investment and set up as new stores, not through acquisition of existing retail stores.
- Sourcing from small industries: Like the single-brand requirement, at least 30% of the value of the manufactured or processed products must be sourced from Indian cottage industries. Note that the procurement of fresh produce is not covered by this condition.
- Minimum population requirement: FDI only permitted in cities with a population of more than 1 million (determined by the 2011 census). Note, however, that the above requirement to invest in backend infrastructure can be anywhere in India, including in states that have not approved FDI in multi-brand retail.
- No online or wholesale trading: the entity attracting the investment cannot trade online or via a wholesale model. Although FDI is permitted in cash & carry wholesale trading, any FDI in such a business must be through a different entity.
- Approval procedure: every application seeking approval for FDI in multi-brand retailing must be approved by two government departments – first by the Department of Industrial Policy and Promotion and then by the Foreign Investment Promotion Board.
The less onerous and simpler requirements for FDI in single-brand retail have, unsurprisingly, caused that sub-sector to be by far the more popular of the two. Government figures released in December 2014 show that 24 applications had been made since April 2010 with 18 approved and 6 pending. Total FDI in that period stood at USD259 million.
In contrast, only one application for FDI in multi-brand retail has been received – from Tesco, the UK's largest retailer. Tesco's application to invest USD110 million into a joint venture with the Tata Group was approved in December 2013. Trent Hypermarket, the joint-venture entity, operates under the Star Bazaar brand and has five outlets in the states of Maharashtra and Karnataka. It recently announced plans to raise USD40 million to fund further expansion.
However, Tesco's investment may not be a sign of things to come from other operators. There is considerable uncertainty over whether any new applications for FDI in multi-brand retail would be approved. The BJP, which forms the current government, was strongly opposed to further FDI liberalisation in the retail sector whilst it was in opposition. Whilst the rules on FDI have not been repealed, there is a concern that any new applications would be rejected (Tesco's application was made and approved during the tenure of the previous government).
Even in the event that new FDI multi-brand applications were not opposed, the complex regulations mentioned above mean that entry into the market is unlikely to be straightforward. A key concern relates to potential quality control issues arising from the requirement in certain circumstances to source at least 30% of goods from Indian cottage industries.
In spite of this, this opening up of the Indian retail sector (albeit heavily regulated) is a significant change from previous policy. With reforms aimed at unclogging supply bottlenecks, increasing amounts earned by farmers by cutting out middlemen and pumping investment into cold storage facilities, there will be many in India lobbying for further relaxation of the rules. As the value of the Indian retail sector surpasses USD560 billion, there are likely to be many outside of India who will be sharing that same wish.