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RETAIL POLICY ISSUES REGULATION OF RETAILING IN INDIA: ENTRY OF FOREIGN RETAILERS INTO THE DEVELOPING ECONOMIES

THE STATE OF REGULATION

For the worlds retailers, there can be little doubt that India is seen as the Promised Land. Indias gross domestic product is expected to grow by nine percent in 2007, its highest growth rate in 18 years. While India is currently on Chinas tail, it is not expected to be behind for long: analysts at Goldman Sachs predict that India will be the worlds fastest-growing economy over the next 0-0 years. Modern retail, which accounts for two to three percent of the market right now, is expected to grow at a compound annual growth rate of 0 percent, from USD8 billion in 2006 to USD0 billion by 2010. Overall, Indias retail sector is expected to grow from its current USD0 billion to USD27 billion by 2010 and USD6 billion by 201. Until now, regulation has kept most foreign retailers at bay. Current Government policy prohibits foreign direct investment in retail trading except for single brand retail that fulfils the following conditions: Foreign equity does not go beyond 1 percent Foreign Investment Promotion Board (FIPB)/Department of Industrial Policy & Promotion (DIPP) approval has been issued Products to be sold are of a single brand only Products are sold under the same brand internationally Single brand products covers products that are branded during manufacturing Additions to the product categories to be sold under single brand require fresh Government approval1

BY PROFESSOR ALLAN FELS, AO, DEAN, AUSTRALIA AND NEW ZEALAND SCHOOL OF GOVERNMENT

Intense debate currently centres on what percentage of foreign ownership should be allowed and whether further liberalisation of the FDI rules should occur, particularly in the retail sector. The Governments stance has vacillated for years. In 199, in the first flush

1. FDI is governed by the Foreign Direct Investment Policy of the Government of India and the Foreign Exchange Management Act, 1999. Foreign investment is permitted in virtually all activities without government approval, except for a few strategic sectors. FDI policy is framed by the Department of Industrial Policy & Promotion (DIPP), the Ministry of Commerce & Industry and the Government of India.

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Intense debate currently centres on what percentage of foreign ownership should be allowed and whether further liberalisation of the FDI rules should occur...

of economic reforms, the law was changed to permit foreign-owned operations, but no big player secured the requisite approvals. Three years later the restriction was re-imposed and maintained when the Hindu nationalists won power in 1998 with the support of many small shopkeepers. Politics has been driving most regulatory reform to date, and that seems unlikely to change in the next few years. Indias 12 million mom & pop retailers are at the heart of the debate. Domestic and foreign retailers with sweeping plans to set up nationwide chain stores are on one side, small shopkeepers and unions who fear being crushed by these emerging supermarkets are on the other. In a dramatic illustration of how heated this issue is, hundreds of farmers and small-scale retailers protested against foreign investment on the streets in major cities like Delhi, Mumbai, Bengaluru and Kolkata on August 7, near markets where vegetable sellers usually sell their goods. Wal-Marts joint venture agreement with Bharti Enterprises to open 1 wholesale retail stores together by 201, which was finally signed and announced on August 6, was the fuel used by organisers of the rally. Wal-Mart effigies were burnt and Quit Retail slogans were cried during the protests, tying into Indias Independence month and the Quit India movement that began on August 9, 192. It was this movement that finally led to the end of British rule 6 years ago. Evidence of just how serious these concerns are being taken by the ruling parties can be found in a letter leaked to the media written by Congress Party leader Sonia Gandhi to Indias Prime Minister, just weeks before state elections in Punjab and Uttar Pradesh. I have received suggestions from many quarters about the desirability to first study the possible impact of transnational supermarkets on the livelihood security of those engaged in small scale operations. I thought I would convey

this to you so that you may consider having the relevant issues properly examined before further decisions are taken, the letter reads. Ghandi may have no official position in government, but her interventions carry enormous weight within the Congress party. In January, after Ghandi voiced concerns about the compulsory acquisition of farmland for the creation of Special Economic Zones, the federal government suspended further approvals of SEZ projects until a rehabilitation policy for the dislocated was implemented2. Political analyst in India, Mahesh Rangarajan, says that with one state election every six months until the general election in May 2009, Indias political environment is particularly sensitive. Mrs Gandhi is playing to the gallery and echoing the concerns of the large constituency of people who are fearful of economic reform the retail trade is a very big employer. And lets face it, Wal-Marts reputation even in the US is not that great, Rangarajan says in an interview with the Financial Times. Playing in the background are policy debates such as whether to develop a compulsory license regime that regulates the grocery, fruits and vegetable retail industry3. Under the proposal, any store selling these goods in premises over 10,000 square feet would have to seek a license from the local administering authority. Hypermarkets planned by groups such as Reliance and Bharti would be directly affected by a regime along these lines. These retailers would only be allowed to operate in specified catchment areas, minimising the scope of competition between them and local stores. One senior government official quoted in the Economic Times said the zone changes for Delhi are being finalised and will be ready for implementation by January 2008. The same model would be followed in other states.

2. Financial Times 7/2/2007 Engaging India: Gandhi v Wal-Mart 3. Economic Times 18/6/07 Is it the return of the License Raj? The Ministry of Commerce, Urban Development and Labour is considering this policy.

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The move is aimed to protect the interest of local kirana stores from the competition thrown up by unfair competition from large corporate retailers. Changes such as the proposed zoning plans appear to be designed to slow organised retail expansion in general; they do not discriminate between domestic and foreign retailers. Other regulatory changes in the pipeline have been proposed with foreigners specifically in mind. There is frustration that foreign investors appear to be circumventing regulatory roadblocks such as capped ownership rules or outright bans in some areas. In its recent proposal for a national policy for organised retail, the Communist Party of India said that foreign retail chains would accelerate the penetration of organised retail and sabotage any attempt by the government to regulate the sector in order to protect the interests of the small retailers and farmers. The UPA government should take a categorical position on this issue. Not allowing MNCs to operate in the retail sector should be the starting point of the national policy on retail. The same proposal directly accused Wal-Mart of circumventing bans on retail by entering via the back door in its joint venture with Bharti Enterprises in the wholesale space. The UPA government should also abandon the moves to permit FDI in retail trade through the backdoor, as in the case of the joint venture between Wal-Mart and Bharti whereby the former proposes to operate in the cash-and-carry segment while the latter is in the front-end. It is more than obvious that this proposed joint venture is nothing but a subterfuge, to circumvent the existing policy regime, which does not allow FDI in retail. Franchise agreements have not escaped similar scrutiny. The Foreign Investment Promotion Board (FIPB) is currently

examining the entire franchise sector to ensure that multi-brand retailers are not entering India under jointly-owned franchise agreements 4. There are some signs that it is getting harder to secure regulatory approval for franchise agreements, and some major foreign companies are pulling out of negotiations until the dust settles. Starbucks originally lodged an application with the FIPB to open stores with local owners under a franchise agreement last year. It was told to consider the foreign direct investment route instead. In May its application to open jointly-owned single-brand stores with its Indonesian partner VP Sharma and Indian partner Kishore Biyani was rejected by the FIPB for breaching the 1 percent foreign direct investment cap. Its second application, which was submitted with a revised ownership structure, was rejected in July and the company responded by announcing that all plans to enter India were now postponed. This was despite an announcement in May that Starbucks planned to open 100 stores by the end of 2007. No reasons were issued for the postponement and no timeframe was alluded to.

Pizza Hut, Lacoste, Mango, Chanel, Louis Vuitton, Nike and Marks & Spencer have all entered via franchise agreements.

FOREIGN INVESTMENT ENTRY STRATEGIES

Since foreign retailers can enter India through some routes, the existing bans or caps on foreign direct investment have not acted as outright entry restrictions. The fallout has been twofold: India is losing some foreign investment while policies remain unclear, and for foreigners wanting a foothold, the entry process has become opaque and complicated5. To date, franchising has been the preferred route through which foreign retailers have entered India6. Pizza Hut, Lacoste, Mango, Chanel, Louis Vuitton, Nike and Marks & Spencer have all entered via franchise agreements. The big multinational supermarket chains have been chomping at the

4. FDI norms to check franchisee pacts Economic Times 22/6/07 5. Mukherjee, A. & Patel, N, FDI in Retail Sector India Indian Council for Research on International Economic Relations (ICRIER) New Delhi, 2005 p. 19 6. Mukherjee, A. & Patel, N. as above, p. 109

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bit to enter India, and the only ones to have done so are Metro Cash & Carry GmbH, Shoprite Checkers of South Africa and most recently WalMart, which has signed a joint venture agreement but not opened its first wholesale outlet. Metro was the first company to bring in 100 percent foreign direct investment through this route and has taken tentative steps so far. It started out with two outlets in the suburbs of Bengaluru in 200 and now has a third outlet in Hyderabad, but has battled regulations such as a ban on trade in agricultural products under the Agricultural Produce Marketing Cooperatives Act since7. Metro announced in December 2007 that it plans to open another 1-18 stores by 2009. Wal-Marts plans are similarly cautious. Despite the perception that once in, Wal-Mart will rapidly expand, its plan so far is to open just 1 wholesale outlets with Bharti Enterprises by 201. Given that it is the first time Wal-Mart has entered a country via the wholesale sector, the aim appears to be investing and developing a supply chain to prepare the company for the day that all remaining barriers to investment are removed. The typical facility will span between 0,000 and 100,000 square feet and the president of Wal-Mart in India, Raj Jain says building the supply chain will be the companys biggest challenge. We will work with and develop a network of food processors, farmers, and logistics service providers to put in place a cold supply chain that will minimise wastage from the farm to the table, Jain says 8. Another arm of the venture is an agreement to supply Bharti Retail with its products, which is setting up frontend retail stores 9. Bharti Retail has also entered a franchise agreement with Wal-Mart, which will see Wal-Mart provide technical support to Bharti Retail.

Carrefour, which has long been rumoured to be in discussions with the Mumbai-based Wadia Group and Indias leading cookie maker, Britannia, announced in April that its plans to form a joint venture in the wholesale space were on-hold until policy issues on foreign direct investment in retail are made clear.10 Tesco revealed in June 2007 that it would wait for changes in FDI regulations before entering India.

BENEFITS OF FOREIGN INVESTMENT

Competing with the fear that 12 million mom & pop retailers will be crushed by the entry of supermarkets is a chronically inefficient supply chain. Modern retail chains drive efficiencies in the process of distribution and invest in infrastructure that would otherwise be left to governments to build. Outlined below are some of the benefits that flow from foreign investment in retailing11 : Faster take up of modern retail formats Improved productivity and efficiency of the retail sector Enhanced sourcing Improved quality of employment Investment in supply chain Reduced number of intermediaries because of closer integration of suppliers, logistic service and retailers Linked local suppliers, farmers, manufacturers to global markets Lower prices for consumers Improved product quality and service for consumers

India has a particular need for foreign investment in distribution on a large scale. Approximately 20-0 percent of perishable produce is wasted due to multiple intermediaries, wastage during transportation and storage, high cycle times and an absence of cold storage systems12. The supply chain would be made more efficient through economies of scale in procurement and transportation, bulk storage, trend

7. The Government of India has asked state governments to allow trade in agricultural products under the Act and eight states have so far removed the restriction. 8. Business Week WalMarts Great Indian Adventure 9/8/2007 9. Wal-Mart press release 6/8/2007 Bharti Enterprises and Wal-Mart join hands in wholesale cash and carry to serve small retailers, manufacturers and farmers 10. Reuters Carrefour puts India entry on hold report 27/4/2007 11. Mukherjee & Patel, as above, p. 41 12. PWC retailing report, 2006, p. 36

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forecasting and improvements in sales analysis patterns to minimise inventory. German chain store Metro and its three distribution centres in Bengaluru and Hyderabad have gone some way to achieving these efficiencies. Metro has launched a supplier relationship management portal to modernise supply chains and it has partnered with the government of Karnataka to improve the infrastructure for fisheries in the state by building and planning auction houses. Metro has invested over USD million in infrastructure in India to build humidity and moisture control facilities. An important point is that foreign retailers source the vast majority of their products locally. German chain Metro says it sources 9 percent of its products from India and Carrefour buys about 90 percent of its products locally for its hypermarkets in China. With these benefits come socioeconomic costs, such as the dislocation of small farms and firms who are potentially excluded from the supply chain. Much of this dislocation is caused by the shift to specialised suppliers and wholesalers who meet quality and safety standards, consolidation in the supply chain and the removal of intermediaries. Metro has started this process in India by launching a knowledge and training centre for farmers near Bengaluru to train and encourage farmers to clean, sort, grade and pack agricultural produce inline with international standards, and initiating training for Indian sheep farmers. The costs associated with dislocation are at the heart of the debate. But no one is sure how significant these costs would be if the door to foreign investment in the retail sector were swung open. A study to attempt to quantify the impact of trans-national retailers on the local, unorganised retail sector was commissioned by the Government of India in February 2007

following Congress President Sonia Gandhis demand for an examination of these costs. Interim results were reported to the Government by the commissioned organisation, the Indian Council of Research in International Economic Relations, in mid-July of that year, and the Government, dissatisfied with the findings, asked the ICRIEC to enlarge the sample size. The interim study reportedly found that organised retail was not harming the countrys farmers and was unlikely to drastically hurt the neighbourhood stores13. It added that in the initial stage, 9 percent FDI in multi-brand retail should be allowed, which could be raised to 100 percent in three to five years depending on the sectors growth. The ICRIEC was initially asked to study 20 cities with malls in which organised retail is at a nascent stage. The Ministry of Commerce has requested that the entire kirana sector be covered in greater detail and gave the ICRIEC an extra four weeks to conduct the study. Other studies reportedly support the ICRIECs initial findings. A three-year report conducted by the Delhi-based Academy of Business Studies and World Trade Centre, Mumbai, at the behest of the Ministry of Commerce in 200 found in its interim report that the opening-up of retail to foreign players would help Indias exports14. It has recommended opening the retail sector on a regional basis because of the stark difference in local tastes and demand, and reportedly observed that multi-brand stores are the most successful form of retail in India.

For many years India has had an old style monopolies and restrictive practices form of legislation based on UK legislation of the 1950s...

INDIAS COMPETITION LAW

India has been in the process of developing a modern competition law. For many years India has had an old style monopolies and restrictive practices form of legislation based on UK legislation of the 190s but this has generally been viewed as ineffective.

13. author unknown, msn.co.in, Dissatisfied government returns retail study report 3/8/07 14. Rituparna Bhuyan FDI in retail on regional basis can aid exports Business Standard, New Delhi 6/8/2007

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In recent times, India has enacted a modern competition law with the basic characteristics of conventional competition laws of developed countries. However, the law was initially successfully challenged as unconstitutional. The grounds were that it combined judicial and executive powers in one body, the Indian Competition Commission, despite constitutional requirements for a separation of such powers. An amendment, which received presidential assent towards the end of 2007, seeks to address that issue although some doubt remains as to whether it goes far enough to meet the concerns of Indias courts. That amendment has now become law although there was considerable opposition to the whole law from Indian business groups. Should the law survive constitutionally then it contains provisions of relevance to the retail sector prohibitions on cartels, anticompetitive mergers and abuse of dominance. However, there are some doubts as to whether the law will have a very big effect on retail in early years. This is because the market shares of retailers are not large enough to trigger concerns about dominance. Also, mergers are not likely to generate market shares of concern. The main possible mergers could be in the form of foreign acquisitions of established Indian retailers. In such circumstances if the foreign retailer has no presence in India but is simply seeking to enter India by acquiring local businesses it is unlikely to fall foul of the merger law provisions prohibiting mergers that substantially lessen competition. If the foreign entrant has little or no role in India then an acquisition of an Indian business will not substantially lessen competition. However, in coming years, as concentration in Indian retailing increases and as the law starts to be applied more vigorously and effectively, it will start to play a central role in the evolution of Indian retailing.

For the moment, the main action concerns government laws and regulations that relate to the retailing sector. These laws obviously have a considerable focus on foreign acquisitions in Indian retailing to the extent that the focus does not necessarily go to the heart of concerns in developed countries about dominance and retail selling and buying power. To the extent, however, that some of the restrictions apply to retailers of any kind they overlap into areas that are the traditional province of competition laws. But they are obviously driven by a somewhat higher concern to protect small business from competition from big retailers than by an emphasis on purely protecting competition itself. If it were, then the emphasis would be on whether or not there is harm to consumers rather than simply harm to small business competitors.

acknowledged and not unduly hindered. While it is true that some dislocation of traditional retailers will be felt, time will prove that the hardship brought will not be substantial. Competition law is being created and adopted across Asia but in the immediate future its impact is not expected to be large. Competition laws only become vital as time passes and retail becomes concentrated in the hands of a few powerful companies, whether or not these companies are foreign or domestic. In conclusion, the issue that India must grapple with now is the impact reduced competition brought about by retailer concentration will have on consumers and the ways in which competition laws and policy can stop this grab for power before it is too late.

OUTLOOK: COMPETITION POLICY IN THE DEVELOPING WORLD

The impact of modern retail formats and foreign investment is firmly on the agenda in India right now. However the focus has been concern about the displacement of small traditional retailers, coupled with unease about the level of foreign investment and its owners ambitions, rather than concern for how the chips will fall in the long term. To a large extent this focus is explained by politics. In India, where 12 million mom & pop retailers are the traditional fruit and vegetable vendors, whether or not to relax tight foreign investment controls and let Wal-Mart, Carrefour and Tesco into the market is a highly charged socioeconomic debate being driven for the most part by self-interest groups. These issues must be put to one side because the more important debate lies in the parameters of competition policy. The benefits brought by modern retailers must be

The benefits brought by modern retailers must be acknowledged and not unduly hindered.