வாசக  நண்பர்களே, देवियों और सज्जनों, mesdames et messieurs, signore e signori,

Welcome to a new round of CRI’s Vaad-Prativaad. The topic on the floor this time is something that has seen enormous discussion, thankfully, on twitter and in newspaper columns: The FDI ‘Reforms’ are a Boost to India’s Economy. Unfortunately, little clarity has been created on an issue that will affect millions as writers and debaters in the various fora have not been talking to each other but only concerned with saying their piece. Through this Vaad-Prativaad, CRI hopes to pit two eminently qualified persons against each other in a format which allows quick exposure of any flaw in logic or fact. CRI is fortunate to again host two very knowledgeable participants in this Vaad-Prativaad. Both work are well-versed with the subtle nuances of international trade and domestic markets and we can learn much from their verbal sparring.


Speaking for the motion is Ritwik Priya. Initially trained as an engineer, Ritwik went on to complete an MBA from the prestigious Indian Institute of Management, Ahmedabad. He is currently based out of London, where he works as a consultant. Ritwik is an avid follower of Indian public policy and the world macro-economy. Please note that all opinions stated in this Vaad-Prativaad are Ritwik’s own and have absolutely no bearing on Ritwik’s employer.


In the farce that Indian political theatre often is, a new act was played out over the last couple of weeks since UPA-II announced its decision to lift the restrictions on, and let state governments decide on whether or not to allow 51% FDI in multi-brand retail in their respective million-plus cities. Old positions were reversed. Xenophobic demagoguery found a new voice. Old letters were dug up. As is usual in Indian public discourse, there was a lot of heat and very little light.

The political opportunism on display, from both the Congress and the BJP, was not very surprising. What was surprising, though, is that in an era of floundering investment and dropping growth, the proposal did not receive unequivocal support from the right-leaning intelligentsia. I first put it down to the Indian right’s reflexive anti-UPA, anti-Congress stands. But it now seems that the objections to allowing foreign investment and ownership in Indian retail are multi-faceted and infused with some very commonly held intuitions.

As the forum allows me a chance to respond to arguments opposing my point of view in a later piece, let me focus on the positive case for FDI in retail in India rather than critiques.

The default decision should be to allow

At one level, the central government’s decision only moves the needle back somewhat in the direction of what should have been the default state of affairs in the first place. Should foreign firms be allowed to own 51% in multi-brand retail chains in India? Should foreign nationals be allowed to travel to Banaras? In the second question, the ‘Banaras’ is perhaps wholly irrelevant, the ‘foreign’ only somewhat more relevant. Why should the first question be treated differently? When it comes to simply allowing a firm to carry out business in our markets, the sector in question and the country of origin of the firm don’t really matter.

I don’t mean to be glib, or to stake out a hardline laissez-faire position. I simply wish to remind readers that even before we delve into utilitarian concerns, there is simply the question of freedom. Do we have a good reason to disallow a specific economic activity by a specific group of people? The empirical record of modern history says that the answer to that question is usually no. The burden of proof is high and lies with those who say yes – do they have confidence that the welfare calculus is undeniably negative? If not, the presumption lies in the favour of allowing individuals and firms to own assets and to compete as they see fit. Allowing is not the same as imposing.

This is especially important given the specific structure of the central government’s directive which leaves the final decision to respective state governments. Not only is there no imposition of foreign capital, there isn’t even an imposition of the ‘allowance’ of foreign capital.

In fact, the right questions to raise about the current proposal would be – why only 51%? Why the difference between single-brand and multi-brand retail? Why only million-plus cities? These are the places where the central government has still imposed its own will upon that of the state governments and of private firms and individuals, and insisted that it needs to unilaterally still disallow certain categories of people and activities. But I will take this something over nothing any day.

Impact on farmers and small retailers

Let’s grant for a moment that the rules are indeed agreed upon by the states and that we do end up with a proliferation of Walmarts and Carrefours in India. Which producers do we suspect might be affected? Retail is about 15% of India’s GDP, and employs about 25% of our employed labour force of 390 million people. With nearly 10 shops per 1000 people, or more than 10 million retail outlets in the country, the number of people employed by the average retail operation is less than 10. About 70% of retailing in India is food. Clearly, it’s the farmers and the small retailers that we are concerned about.

So what will be the impact of this policy on retailers? The short answer is, we don’t really know. But we have clues that we need not be overly concerned. Even after many years of growth, modern trade still accounts for less than 5% of India’s retailing. Most consumer goods companies still reach India’s many towns and villages through elaborate multi-tier distribution networks. Companies often set up directly owned or single tiered franchise networks, only to run into problems of scale or credit recovery, and end up falling back on local distributors, dealers and wholesalers to carry the ‘last mile’ for them . It is hard to see this being dismantled in short order simply because some foreign capital rushes into retail. FDI does not make the scale and customer credit problems go away – that leaves enough space for the traditional retailers to compete in.

Even more fundamentally, the entire discussion suffers from a version of the lump-of-labour fallacy. The retail growth of India is not complete. We are not even close to producing and efficiently providing all the consumer goods and comforts that people of even middle-income countries take for granted. In a growing retail landscape, finding space for Walmart does not mean displacing the neighbourhood kirana store. Again, I don’t mean to suggest that no small retailers will be negatively impacted. There are winners and losers from trade and from technological change, especially ex-post. But unless we are strongly convinced that the losers and the net loss clearly outweighs the gains, impeding a new section of firms from doing business means risking further growth potential, which is a net loss for most.

As for the farmers, they currently operate in a supply chain that passes only about one-third of the final prices back to them. This is substantially lower than the same figure in more developed economies dominated by organized retail. To the extent that large foreign chains are able to leverage scale and expertise to any degree, they will have more scope to pass on their receipts to the farmers. They may choose to, or they may not. But this is an option with a positive value.

It is not my contention that we know for sure that balance of judgement lies necessarily in favour of small retailers or farmers. But we have enough clues to be optimistic. And this is even before we have considered the other side of the welfare equation – the consumers.

Investment – at current levels, more is certainly better

Investment holds a rather special position in the study of macroeconomic systems. A strong case can be made that in the short term, investment drives the business cycle. At the same time, capital is nothing but accumulated investment and connects the present with the future, driving the long run performance of the economy. Research from the IMF shows that in the present slowdown of growth prospects, a drop in business investment is the key driving factor.

We need to invest as much as we can – in just about everything, especially human capital. But this investment should create what are known as hard assets (which can include productive human capital) rather than simply financial assets. To the extent that investment by domestic firms may be constrained by any factors, FDI is a way of boosting the economy as well as the future productive capacity of the economy. Consider the fact that India has far fewer restrictions on FII portfolio flows than on FDI ownership. This is a rather perverse system, where we welcome investors with hot money portfolio flows to punt on our equity markets, but place a thousand restrictions on firms actually setting up buildings and factories and warehouses and employee training programs.

In my last job, I worked in the supply chain team of a consumer durables manufacturer in India. We always had some contracted staff to help out with ERP related execution. These gentlemen had honed their trade at a large Indian multi-brand retail chain. They were indispensable – indeed, they were almost more important to the functioning of the team than the managers in it. That’s human capital! A proliferation of retail chains is likely to build a veritable army of such people. This is but on example, but it is clearly a more productive use of foreign capital and a more sustainable way to build a capital rich economy than our current model. That’s part of what FDI supports.

Indeed, the threat of entry of a new competitor is itself powerful enough to force incumbents to innovate and invest, creating jobs and wealth along the way. Reducing barriers to entry is among the fairest and most high RoI decisions that a government can take, and though this is particularly important when the incumbents are large and challengers small, the logic still holds when the relative sizes of the two are inverted.

Again, the sector in question is irrelevant. We want more hard assets and more competition all round. We should have FDI in retail, in aviation, in media, wherever. At the very least, we have no business disallowing it.

Not panacea, but largely a force for the good

I hope I have been able to show that the welfare calculus of FDI is on solid grounds. Indeed, even we were to not be completely convinced of that, we do have ample reason to believe that outright disallowing FDI in retail is on rather flimsy foundations.

The reform was much needed and in all fairness did not go far enough with its proposals. But in deference to the principle of not letting the perfect be the enemy of the good, let’s simply appreciate the fact that something has moved, and make the most of it.

 *        *        *        *         *        *        *        *


Speaking against the motion is N. Muthuraman, a former Director (Ratings) at CRISIL. Muthuraman currently runs a boutique investment banking firm, RiverBridge, focussed on SMEs. He has experience of 15+ years in the financial services industry and is a regular columnist for the weekly column “Cut to the Chase” in Hindu Business Line (www.chasecut.blogspot.in). He also serves as a corporate trainer in the area of credit risk management.


FDI in Retail – Are we there yet?

The policy of Govt. of India to allow 51% FDI in Retail sector has evoked sharp reactions both for and against the move even within the ‘Right wing’ public intellectuals. The table below captures a sample list of opinion makers, all of whom one would normally consider to be “pro reform”, “pro business”, “right wing”  personalities!

People for and against FDI in retail:

For Against
C. Rangarajan Arun Jaitley
Jagdish Bhagwati Subramanian Swamy
Raj Thackeray Prof. Vaidyanathan
Atanu Dey S. Gurumurthy
Chengal Reddy (Farmers’ Association Leader) Keith Vaz (Labour MP, Britain)
Chetan Bhagat Kanchan Gupta
Tavleen Singh Shekar Swamy


I am sure all of them are intellectuals in their own right and have formed their opinion, after weighing the pros and cons of this serious policy decision, which only proves that there is definite merit in both sides of the argument. It also becomes clear that, in all likelihood, the benefits promised by one side and the fears articulated by the other side are both highly exaggerated.

A wise course of action, in such a situation, would be to adopt a gradual phased out approach in opening up this sector to foreign competition, much as the same way China did in, which we will look in greater detail in just a while.  India has a compelling case for adopting such a gradual approach, and just six arguments for such an approach are presented below.

Argument 1: The size of the retail sector, in terms of number of people employed, is disproportionately high in relation to the rest of the economy, making it difficult to absorb those displaced from this sector due to foreign competition, even with appropriate training & re-skilling. Few more years of good growth in the economy may provide the required elbow room for this structural adjustment. See the number of people employed in some of the key sectors of the economy:

Industry-wise employment data

Industry Number employed directly Source
Agriculture 26 crores CIA Fact Book
Construction 4.4 crores Govt. of India
Retailing 4.0 crores Several sources1
Textile 3.5 crores Govt. of India
Information Technology 0.25 crores Nasscom, Govt. of India
Gems and Jewellery 0.18 crores Govt. of India
Steel Industry 0.05 crores Govt. of India
Cement Industry 0.01 crores Govt. of India
Total Organised Sector 3.8 crores Reserve Bank of India

1: Many sources indicate 12 million retail outlets in India, employing 40 million directly, including National Sample Survey 2009-10

It is a reasonably established conclusion that FDI in retail will result in efficiency improvements which will, at least in the short to medium term, result in displacement of labour! To put this challenge in perspective, in a span of say 5 years, 10% of those employed in retail sector gets displaced, that lot will comprise of 40 lakh labour, which is larger than all those employed in the entire IT & BPOsector in India, as on date! Imagine the efforts involved in re-training and re-skilling, and the effect it will have on the labour supply, wages, unemployment levels and other unintended consequences! This argument alone makes a compelling case for adopting a gradual opening of the sector, but with clear timelines for firm action lest we miss out on these efficiency improvements forever!

Argument 2: FDI is already practically open in all segments of the industry, except the customer facing retail shops for the last 6 years (though cash & carry was opened in 1997 itself, it was highly restrictive and automatic approval was allowed only since 2006). Almost the entire value chain of the retailing sector, including sourcing from farmers, logistics, cold chain infrastructure, warehousing, wholesale distribution, etc. are all already open to FDI. Almost all the benefits that are promised because of FDI – minimising wastage of perishables through cold chain infrastructure, eliminating middlemen to procure directly from farmers, etc. are all possible without having a customer-facing store yet!

Metro Cash & Carry, Walmart, TESCO, Carrefour, etc. already operate in India with domestic JV partners. This is in fact a huge complementary business to the unorganized retail sector, many of whom have started sourcing from these big-box wholesale stores and enjoying the benefits of their investment. This takes the wind out of most of the arguments placed by the supporters of this policy now – such as higher prices to farmers, lower wastage, better storage infrastructure, etc. as all of these can be derived under the existing policy regime itself, without opening 51% FDI in retail. Allowing few more years for FDI in retail will not deprive most of the benefits that are promised in any way.

Argument 3Missing “level playing field” is a serious charge levelled by many of the opponents to the policy. The crucial factors are the access to credit and cost of funds.  Retail is a working capital intensive operation; access to credit and interest rates play a crucial role in determining profitability and survival of the industry. Domestic credit to the private sector as a % of GDP is 50% in India, as against 200% in United States & United Kingdom and over 150% in Canada & Australia. This low level of credit penetration in India is a serious handicap for all sectors, and more so for the retailing sector, which operates on fairly thin profit margins (Profit After Tax/Revenues for Walmart is 3.6% in 2011!).  Interest rate is also another crucial factor. The tight capital account control in India prohibit Indian firms from raising foreign currency loans in services sector (except Hotel, Hospital & Software). In contrast, foreign players can bring in funds in the form of subordinated debt or trade creditors (extended credit from say Walmart China to Walmart India) giving them unfair advantage in cost of funds.

These issues can be addressed over a period of few years as India gradually opens up its capital account and improves credit penetration levels, before exposing the local players to the onslaught of foreign competition.

Argument 4: Reforms in Agriculture Procurement should ideally precede opening up of the sector to foreign investors. The current monopsony situation (single buyer, the opposite of monopoly which is single seller) enjoyed by the well-intended but highly perverted APMC Act need urgent reforms so that the farmers / producers have full control on their product and its pricing/marketing. The opening up of the sector to large multinationals could result in replacement of the APMC monopsony by Walmart monopsony, perpetuating the unfair stranglehold on the farmers. Foreign players, with all their clout and influence on politicians /political parties, could easily lobby with the Govt. to pry open the APMC Act and other such impediments, which the domestic lobby has failed to do.

Several other important reforms such as implementation of GST, rationalizing the inspector raj in retail sector such as those from Shops & Establishment Acts, Weights & Measures, Labour inspectors, etc. are urgently needed to strengthen the hands of the domestic retail players before exposing them to the onslaught of foreign competition.

Argument 5: Conflating Organized Domestic Retail and FDI is a common mistake made by most proponents of this policy. “Why should I care if the next big retail shop is owned by Ambani family or  Walton family?” and “Why should I bother about the source of capital, if business model is the same?” are the common refrains that you hear from them. This is a gross error of judgment of the potential for devastation that MNC retail firms can do. Consider these points:

  1. The ability to absorb losses (and willingness to remain so as a competitive strategy) are far far higher for MNCs than for domestic players. That’s why you don’t see serious predatory pricing from domestic big box retailers.  In contrast, MNC players can incur losses for 10- to 20 years in a row (which is a flea bite in their global scale) and still continue to remain interested in the market, if the future potential for growth is large enough. No Indian company can ever imagine doing that!
  2. The cost of capital, even for the highest rated Indian company, is much higher than the rate at which MNCs can raise funds.  The risk associated with India is high, both from debt perspective (international banks) as well as equity perspective (FIIs). Accordingly, the return expectations (and thereby cost of funds) are significantly higher for Indian players than for MNCs.  To put things in perspective, Private Equity investors expect returns of 25% per annum or higher from their Indian investments, in contrast to cost of equity of less than 15% in U.S. This has a serious market distortion in the retail industry, which operates at thin margins and relies heavily on leveraging.
  3. The expertise of MNCs in retailing business in general, and global sourcing in particular, are far far higher than those of Indian players. With minimal local sourcing norms (which could also be subverted as was done recently in the case of single brand FDI in retail), these MNCs could create serious market disruptions. Few more years of experience for the domestic big box players could bridge this gap to some extent.
  4. The regulatory oversight on MNC retailers is far far difficult than it is on domestic retailers. If Walmart were a country, it would be the 25th largest economy in the world! Given such a dominant global position, MNC retailers will have significant leeway in subverting any regulation that Indian Government can bring in, to create a level playing field. For instance, it could be a nightmare to assess the extent of under / over invoicing for tax evasion, extended credit as a substitute for interest-free lending, private shareholders’ agreements to pervert regulatory cap on shareholding (like many domestic players are doing in the Insurance sector), etc.   The Govt. of India’s handling of the Vodafone case provides ample evidence in this context.

Given these, to conflate Indian big box retailers with MNC retailers, is to equate a street bully with an 800-pound gorilla! This is a serious error of judgment which could prove costly for Indian retail sector in the long run. One could always argue that these issues are identical in every sector; but opening of such sectors (electronics, telecom, etc.) have immensely benefitted the economy and so why not retail? But as mentioned earlier, the impact of labour displacement is far too high in this sector compared to any other sector (save and except agriculture, which hopefully will not see FDI in the next 100 years!) and hence, warrants a cautious approach of opening the sector gradually rather than letting the camel in the tent, and wondering what to do now!

Argument 6: Trust Deficit plaguing the present regime would dampen the spirits of even the most enthusiastic supporter of this policy decision. Consider these facts:

  1. The Government is practically a minority government, atleast on this issue of FDI in retail, where TMC, SP and BSP as well as DMK and few other smaller parties / allies are opposed. Despite being fully aware, the Government has already gone ahead and issued necessary notifications, acting as if under tremendous pressure.
  2. On the floor of the house, the Govt made an announcement just a few days back that the decision on FDI in retail would warrant further consultations and will be presented in Parliament again. The current notification is a serious breach of this statement made in Parliament.
  3. It is widely believed that the Govt. made this “urgent” reform – like an instant noodle – to deflect attention from the monstrous scams that it is facing. Pushing through such an important reform that could have ramifications on such a wide section of population needed greater discussion and consensus, which is missing in the current discourse.

In light of such serious trust deficit, the decision to allow FDI in retail could (and should) have waited some more time to be implemented by a government with a clear mandate. The foreign investors now face significant risk of policy reversal by a subsequent Government – as Prof. Vaidyanathan has suggested the opposition to announce now – which could deter fresh investments and also would further sully the image of India as a safe investment destination!

A gradual further opening up of the sector is a win-win for all

The above six arguments make a compelling case for adopting a gradual approach to opening up Indian retail sector to foreign competition. China has set us a clear example. It opened big-box domestic organized retailing first, and allowed them to flourish for 20 years. Their share gradually increased from 1% of the total industry to 20% during this period, when the unorganized sector had adequate lead time to align themselves to competition with biggies. This was followed by 26% FDI for the next several years before allowing 51% FDI.  A similar approach, with timelines designed to suit Indian context, will prove immensely beneficial to all the stakeholders, while not seriously taking away the benefits of the much needed investments into India.

The following two tabs change content below.
Jaideep A. Prabhu is a specialist in foreign and nuclear policy; he also pokes his nose in energy and defence related matters.

Latest posts by Jaideep A. Prabhu (see all)