Indian Retail: A Backdoor That Leads Nowhere

A government rule that bans retailers sourcing from group companies puts a spoke in international vendors plans

Published: May 13, 2010
Indian Retail: A Backdoor That Leads Nowhere
Image: Vidyanand Kamat

Just when foreign retailers thought they had found a backdoor entry into the Indian retail market, the government has gone ahead and turned it into a wall.

A year ago the world’s largest retailer, Wal-Mart Stores Inc., opened its first India store, in what was probably one of its most circuitous entries into any market. The store is a cash and carry operation where it sells to hotels, restaurants, small stores and other institutions. Apart from this, Bharti Wal-Mart is the sole supplier to Bharti Easy Day stores, run by Wal-Mart’s join venture partner Bharti Retail, which sells to end consumers.

All this to get around the government regulation that allows foreign retailers only in cash and carry retail. Soon after Wal-Mart, Britain’s largest retailer, Tesco set up a similar agreement with the Tata group’s Star India Bazaar stores.

Now, a government circular says a retailer cannot source more than 25 percent of its supplies from a group company. This has put these investments in jeopardy and retailers in a panic.

The circular, put out by the Ministry of Commerce and Industry’s Department of Industrial Policy and Promotion (DIPP) could make Bharti Wal-Mart, Tata- Tesco and other such operations untenable at least for now. “Companies will have to relook at these structures,” says Ramesh Srinivas, executive director at professional services company, KPMG.

Media reports have suggested that Bharti Wal-Mart is seeking a clarification on this from the ministry.
A Wal-Mart spokesperson said in an emailed response, “It is too early to comment on this. We are currently reviewing the new guidelines.”

The circular came as a surprise to those lobbying for or against foreign investment in retail. The finance minister said in his budget speech that the government would deliberate on allowing foreign investment in retail and that it may be a way to counter food inflation.

Since then an intra governmental group has been set up on retail but industry executives say it is at a nascent stage.

Thomas Verghese, chief executive of Aditya Birla retail says the industry expected that the government could allow FII portfolio investment in retail if not FDI. “We were close to a breakthrough but with this they have virtually removed the floor from under our feet,” he says. French retailer, Carrefour is among several retailers who have been looking at such a route to enter the Indian market.

For the anti FDI campaigners too this came as something of a surprise for the same reason although a joint parliamentary committee had underscored how small retailers had been hit by the coming of organised retail. “Global retailers have been doing front end retail through their Indian partners in the garb of wholesale cash and carry,” says Dharmendra Kumar, director of FDI Watch, a coalition of organisations that oppose FDI in retail. “It would only be a mockery of the present government policy of no FDI in front end multi brand retail if Wal-Mart, Tesco, Metro, Carrefour are allowed to have such privileged retailers who alone are buying more than one quarter of their sales.”

The circular also says that cash and carry wholesalers need to maintain records indicating that they only sell to institutional buyers and not consumers. Their buyers now need to show licenses indicating that they are a shop or another institution.

Business at German retailer Metro Cash and Carry, Bharti Wal-Mart’s Best Price Modern Wholesale and Tata-Tesco’s soon-to-open Tesco Cash and Carry stores will be affected by this. But even as these rules tightened media reports have suggested that the government will look at the way in which FDI can be allowed in retail without denting business for India’s more than 12 million small retailers.

For now, even as retailers seek to tweak or clarify this policy, lawyers who created this entry route are now looking for alternatives. “A lot of back room conversations are happening right now,” says Anand Raghuraman, partner and director at Boston Consulting Group.

At a Bharti Wal-Mart store in Punjab, Scott Price, president and chief executive of Wal-Mart Asia underscored how important India is to its growth. In various media reports he has stated that he wants the government to take care of issues related to FDI, GST and providing infrastructure support. He says Wal-Mart will keep persisting with India because its efforts here are critical to its global growth strategy. Markets in the US and other developed countries are saturated and the company needs to establish a bigger presence in emerging markets like India, where modern stores make up just 5 percent of the country’s retail industry.

If their representation does not work, these companies may have to rejig their joint venture structures, making it harder to earn their share of profits from it.

“If you don’t have a joint venture then you will need something closer to a franchise agreement or arm’s length transactions between the two companies,’ says KPMG’s Srinivas.

Others say the circular is vague and does not indicate whether regulation also applies to companies that have been set up under earlier regulation. “The Government of India had set out to make things simpler but has confused things more,” says a senior lawyer who did not want to be named.

Yashojit Mitra, an associate partner at Mumbai-based law firm, Economic Laws Practice says “The company will have to be structured in a way that it doesn’t look like a group company. But if the foreign retailer wants to list the Indian arm or show its revenues in some books, it will be an issue.” Asked what he would do if one of them was his client, Mitra says “I would not advise them to continue. I would ask them to review the structure and future dealings should be avoided until further clarification.”

BCG’s Raghuraman says, “We were talking to some Asian companies about entering the Indian market through this route but now this option is not there.” The government for its part has maintained multi-brand retailing as one of the last spaces of no foreign investment in order to protect poor migrants for whom retail acts as a social security net.

FDI Watch’s Kumar says there may be no further progress because this circular plugs a gap in the government’s policy of not allowing foreign retailers in multi-brand retail.

“This definitely is a right step in favour of retail democracy and minimises monopolistic tendencies setting up in retail sector for the first time,” he says.

But even with the current setback big retailers are looking to get this fixed and BCG’s Raghuraman says “I would say, ‘watch this space’. In a few months it will become clear what’s going on because this is an evolving situation.”

 

(This story appears in the 21 May, 2010 issue of Forbes India. You can buy our tablet version from Magzter.com. To visit our Archives, click here.)

Show More
Post Your Comment
Required
Required, will not be published
All comments are moderated
Adi Godrej: Localise Your Business Abroad
G. R. Gopinath: Jonathan Livingston Seagull