FDI Demystified

 

November 2012


In India, retail accounts for over 10% of the country's GDP and approximately 8% of employment rates. Much of this retail, however, is currently classified as "unorganized" - local merchants running independent operations. Modern or "organized" retail, on the other hand, plays a very small part in the Indian marketplace, accounting for less than 8% of the overall share.

Recently, the Indian government decided to open up their retail industry to greater levels of foreign direct investment (FDI) - a move that had some people criticizing and others celebrating. We fall into the latter camp, firm believers that the decision will benefit the Indian economy and delivers a much-needed push to modernize the retail environment.

Before we discuss its potential impact, let's first look at the details of this new FDI policy. Many opponents of FDI growth in India point to "similar" cases in countries like Mexico or Thailand as cause for concern. But these involve different economic and geographic realities, and more importantly, different FDI policies. The Indian government's allowance of greater FDI comes with some important stipulations to control its growth:
  1. Retail chains backed by FDI may only be set up in cities with a minimum population of one million, which puts tier-2 and tier-3 towns off limits. According to this condition, there are a total of 53 eligible metros and tier-1 cities.

  2. Foreign parties must make a minimum investment of $100 million, 50% of which must go toward back-end infrastructure within the first three years. This will attract long-term players and support holistic, inclusive growth for the entire retail sector.

  3. 30% of products must be sourced from small and medium enterprises, ensuring foreign investment also benefits local suppliers.

The requirement for back-end infrastructure will create jobs, minimize reliance on international suppliers, and bring to consumers better quality products at lower prices. The clause on local sourcing will support small-scale industries as well as farmers who will get better prices for their produce. And the investment in front-end retail will provide jobs in construction and labour, and increase product choice for shoppers. This widespread development throughout the retail sector and its subsidiaries will move our economy forward.

So what will happen to the kiranas and other forms of unorganized retail in India? In the short term we will see a wave of retail consolidation, followed by evolution. As modern trade continues to evolve, the industry will move from one dominated by a few key players, to one that fosters healthy competition among retailers.

Now that India's government has decided to embrace foreign direct investment, global and Indian retailers alike must decide how to respond to this new environment. The outcome remains unknown, but it's safe to say that here in Canada we'll be keeping attuned to India's ever-changing retail landscape.