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FDI in Retail Trading Activities

Published on Wed, Jun 26,2013 | 11:34, Updated at Tue, Jul 02 at 16:25Source : Moneycontrol.com 

By: Rabindra Jhunjhunwala & Sameer Shah, Khaitan & Co.

Since the advent of liberalisation of Foreign Direct Investment (FDI) in India, the Central Government has gradually and very cautiously tiptoed around the issue of allowing FDI in retail trading in India. The retail trading sector in India is largely unorganised and caters to the livelihood of several persons who establish and run very small and scattered “mom-and-pop-shops”. In this background, there has always been a fear that organised retail in general would affect the livelihood of such small retailers. Indian organised retail players such as Reliance, Future Group, D-Mart, etc., have only started establishing their footprints in the last decade or so, and that also primarily in the larger urban centres. Even they met some stiff resistance during their establishment phases.[i] The global retailing giants such as Walmart, Carrefour, Metro, etc., have slowly established their footprints in India through the avenue of wholesale trading. Even this was tested before different courts and the policy to permit FDI in wholesale trading was held as being valid.[ii]

In 2012, the Central Government liberalised the policy further by permitting 100% FDI in single brand retail trading and 51% FDI in multi-brand retail trading. This policy was also challenged and has been upheld by the Supreme Court.[iii] This article briefly explores the changes made and some of the nuances around the issues involved.

SINGLE BRAND RETAIL TRADING

History

In February 2006, the Central Government had permitted 51% FDI in the activity of single brand retail trading with prior approval from the Foreign Investment Promotion Board (FIPB). The quintessential requirement of this form of retail trading was that the products should be branded as per the single brand during manufacturing and they should be sold under the same brand internationally,[iv] i.e., in one or more countries other than India.[v] As of August 2012, 63 proposals had been approved by the FIPB including global fashion brands such as Christian Dior, Dolce & Gabanna, Diesel, Giorgio Armani, Louis Vuitton.[vi] In January 2012, the Central Government liberalised the policy further by allowing upto 100% FDI in single brand retail trading.[vii] Certain additional conditions were imposed, most important of which was a mandatory requirement for sourcing at least 30% of the value of the products sold from “small industries” (i.e., industries which have a total investment in plant and machinery not exceeding US$1 million), etc., from day one of establishment of the Indian company. This was viewed as a hurdle by industry participants as almost all the applicants in this space were conducting manufacturing activities outside India. Applicants demonstrated how it was not possible for them to source their products from Indian small industries. Recognising this difficulty, the Central Government further liberalised this requirement in September 2012 by making this sourcing requirement preferable, as opposed to mandatory, and compliance with these norms would be assessed over a five year period.[viii] Since then, various proposals including proposals by IKEA, Pavers, Fossil, Decathlon, and Le Creuset have been approved by the FIPB.

Sourcing Requirement

The relaxation of the sourcing requirement essentially implies that the applicant should be able to convince the authorities that it is not possible for the applicant owing to its high end manufacturing or other standards to source these products from Indian small industries. In any event, IKEA had sought further relaxation in relation to the sourcing requirements whereby it sought that the compliance with the requirements be computed over a 10 year period as opposed to being enforced from day one. This was relaxed by the Central Government in its September 2012 policy by requiring compliance over a period of five years. Further, in IKEA’s case, the Central Government has apparently permitted for there to be a separate entity engaged in retailing and in sourcing.[ix] However, IKEA was an exception case given the high levels of investment. Interestingly, a similar but mandatory condition has been imposed for multi-brand retail trading as well. The Central Government has provided various clarifications[x] on these issues with reference to multi-brand retail trading, but it is not clear whether these will apply to single brand retail trading also.

Sub-Branding

As explained above, the products being sold should be of a single brand alone. In this regard, certain retailers had been taking a view that sub-brands within a larger brands should be fine. However, recently, the Central Government has issued notices to certain retailers to justify as to how are their sub-brands falling within the single brand requirement.[xi] Probably, if a retailer A is selling sub-brands B and C as “B by A” and “C by A”, then this could be fine. However, it appears that where B and C are brands that are known independent of the main brand A, it is doubtful whether this would be regarded as single brand retail trading or multi brand retail trading.

MULTI BRAND RETAIL TRADING

History

In 2010, the Central Government released a discussion paper mooting the proposal to allow FDI in multi brand retail trading. The paper summarised all the existing policy studies, and examined all the benefits and limitations. The comments received on the discussion paper vehemently opposed the introduction of FDI on the traditional grounds of protection of small traders, etc. Eventually, an Inter-Ministerial Committee headed by the Senior Economic Adviser, Department of Consumer Affairs studied the comments received and the Central Government issued a Press Release in November 2011 whereby it communicated its intention to liberalise FDI in this sector. This move met with tremendous backlash and public outcry, and the Central Government eventually withdrew this proposal. However, in September 2012 the Central Government introduced 51% FDI in multi-brand retail trading with prior FIPB approval.[xii] Through some recent clarifications, it appears that the Central Government will not allow franchisee stores to be established, or permit the Indian company to engage in B2B trading. It must conduct retail trading activities through “company owned and company operated” stores.[xiii]

Amongst other conditions, a sourcing requirement similar to the requirement for single brand retail trading is included, except that the condition is mandatory in this case. The Central Government has specified that the sourcing must be for the front-end retail store and the Indian company cannot distribute the small industry products through other forms of trading.[xiv] The policy prescribes the limited urban centres where such stores can be established, and the eventual implementation of the policy is subject to the States’ decision. Further, a minimum of US$100 million has to be brought in and 50% of the FDI has to be invested in back-end infrastructure. Further, the Central Government has clarified that this investment in back-end infrastructure will only include setting up green field assets and acquisition of existing assets or equity stakes in existing companies will not be counted.[xv]

Till date, there has been no information released about a formal application being placed by any foreign investor for accessing this route of investment; albeit, there have been a number of press reports regarding proposed investment by Walmart in Bharti Retail’s holding company.[xvi]

States' role

The crucial element of this policy is the autonomy of the States that has been preserved. This is consistent with the Constitutional division of legislative powers between the States and the Centre. As on the date of the notification in September 2012, 10 states and union territories had expressed support for this initiative. However, various other states had expressed their displeasure. Needless to say, most of the states that have indicated favour are currently ruled by the Congress which is the political party in power at the Centre, and most of the states that indicated their dissent are ruled by other political parties. Further, given the fact that 11 states are scheduled to undergo elections between now and 2014, it is difficult to predict what the eventual policy outcomes will be. A good example of the possible twists is the State of Himachal Pradesh which until December last year was ruled by the opposition party. The State elections led to a change in guard with the Congress coming in power, and the State has recently been included in the list of states that have approved the policy.[xvii]

Interestingly, various states who are opposing the current policy move permit stores opened by foreign companies operating under the wholesale trading route, and Indian companies operating under the multi-brand retail trading business to be operated. It will be interesting to see the manner in which any legislation prohibiting the operation of stores owned by multi-brand retail companies with FDI in them.

Further, certain investors were concerned whether the States could alter the conditions imposed by the policy (e.g., sourcing requirements, minimum infrastructure), to which, the Central Government has clarified that state laws will apply and the State Government may impose additional conditions.[xviii]

Supreme Court case

One Mr Manohar Lal Sharma (the “Petitioner”) filed a ”public interest litigation” by sending a letter petition to the Supreme Court challenging the policy as being unconstitutional. Amongst other contentions, the Petitioner contended that the Central Government was not competent to pass such a policy. The Supreme Court required the Central Government to present its defence and also regularly monitored the progress of the policy and its incorporation into appropriate regulations framed under the governing legislation (i.e., the Foreign Exchange Management Act, 1999). In certain observations made in open court in January 2013, the Supreme Court questioned the motives of the Central Government in making these amendments and questioned the Central Government on whether this move was meant simply as a gimmick considering no applications had been received for investment thus far. Thereafter, the Central Government filed an affidavit in reply.

Eventually, on 1 May 2013, the Supreme Court dismissed the Petitioner’s petition. It held that the Central Government was well within its legislative and constitutional powers to introduce such a policy. In line with the same constitutional scheme, it was eventually the States’ decision whether they would implement the policy. The Supreme Court also noted how this policy would eventually benefit the consumers and the producers by removing the middlemen who were retaining a sizeable chunk of profits associated with such retailing activities. The decision is consistent on the legal premise with other earlier judgments by different courts on matters associated with FDI.

ECOMMERCE AND RETAIL TRADING

FDI is not permitted in e-commerce if it indulges in retail trading of any form. In this regard, this will affect investment opportunities in Indian e-commerce platforms that are engaged in direct B2C sales, unless, the structure on closer examination permits such activities. Indian sites that provide only listing services and do not engage in direct sales can continue to operate. However, if the e-commerce company where FDI is invited is engaged only in B2B commerce, then there are no issues.

CONCLUSION

Gradually, the Central Government has liberalised FDI in retail trading. Further, as the sector is still in its nascent stage, the regulations have various issues that tend to create difficulties for foreign companies to comprehend and implement. Nevertheless, given the vast potential India presents as a retail market, foreign companies are likely to continue pursuing this market

 
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