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A Little Book on ‘FDI in Retail’ : Impacts on India’s Economy


Author: Narayan Singh Rao

Research Inputs from Jatin Magan, Prashant V Singh, and Nitin Batri

Our parliament is going to discuss the issue of FDI in retail tomorrow (Dec 5, 2012). Presented below is a study on this hot topic considering benefits and drawbacks of this policy. I am happy to present the second little book of the little book series. – Narayan

1. Introduction

In 1991, Manmohan Singh as a finance minister opened Indian markets for foreign investments. He selectively allowed FDI up to 51% in priority sectors. In 1997, FDI up to 100% in sectors like mining, manufacturing etc was allowed. This resulted in a massive inflow of funds in India. Several sectors have now been opened for FDI. National Democratic Alliance also allowed FDI in multiple sectors such as aviation.

1.1 What is FDI?

Under FDI, a foreign investor is allowed to bring in money to invest directly in products or services. This is different from FII (Foreign Institutional Investment) where the funds by foreigners are invested in stock markets.

1.2 Existing Retail Sector in a Nutshell

This sector contributes about 12% to our GDP. With $ 500 bil (~INR 27,00,000 Cr), the retail sector employs about 40 mil (4 Cr) people. If we assume about 4 dependants per employee, there are about 160 mil (16 Cr) dependants on this sector. 70% of this workforce is either uneducated or educated below primary level.

1.3 FDI in Retail

Through this policy, the government claims to achieve:

  • Better prices to farmers by cutting the supply chain (terming them “Bicholiyas” or middleman) and enabling farmers to directly selling their produce to the large retailers
  • Wastage reduction, efficiency enhancement by way of development of back-end infrastructure
    Low prices to the consumers
  • Employment generation (4 mils (40 lakh) direct and 5-6 mil (50-60 lakh) indirect, i.e. a total of 1 Cr employment)
  • Benefits to manufacturing industry by way of 30% mandatory local sourcing

1.4 Concerns over FDI in retail

Current UPA government has further liberalized the investment policy and has cleared FDI in retail. There is a widespread concern from various stakeholders on this proposal of UPA government. One of the major UPA allies, Mamta Banerjee has already withdrawn support from the government. There is the voice of dissent from within the Congress party leaders. The principal opposition party BJP is fiercely opposing FDI in retail. The question is why BJP is opposing FDI in retail while it allowed FDI in several other sectors during NDA government between 1998 and 2004. This paper will throw light on the key objections and also lists what are the alternatives to FDI in retail.

Let us look at these promises made by the government one by one and see how FDI in retail will be beneficial for our country.

2. Existing Economic Process in Retail Sector

We must first understand what this supply chain comprises, which the proposed policy aims to cut short.

Suppose a farmer produces 25 kg of tomatoes and hires a tempo to take his produce to a Mandi. The tempo owner charges him Rs 50 per 25 kg (Rs 2 per kg). He then sells the produce to a wholesaler in the Mandi at Rs 4 a kg. The wholesaler then sells at Rs 6 per kg to a small ‘thelavala’, who hires a thela from a thela owner at Rs 50 per day. This effectively adds Rs 2 per kg to the input cost to the thelavala. This takes the total input cost to Rs 8 a kg to the thelavala. Now the thelavala goes into a society and sells these tomatoes to the end consumers at Rs 10 a kg.

FDI

The farmer is earning Rs 2 a kg, which is likely to be lower than his input costs, so effectively he is earning nothing. The transporter earns Rs 2 a kg minus his cost of transport. The wholesaler earns Rs 2 minus his whatever input costs. The thela owner earns Rs 2 per kg minus his investment cost. The thelavala, the end retailer sells at Rs 10 and earns Rs 2 per kg.

Assuming there are about 4 dependants on each of the parties involved in the above supply chain, there are a total of 25 people dependant on this economic activity. The question is: Is everyone between a farmer and a consumer truly a “Bicholia” here? While in this particular case, not everyone seems to be the middleman, the problems of middleman do exist in our country, which needs to be curbed by developing an effective legal framework and its implementation.

3. The Tall Promises the Policy Make

The FDI in retail will open entry of large retailers such as Walmart, Tesco, and several others. These retailers typically have deep pockets to sustain for a significant number of years.

The government vouches to bring the prices down by eliminating these so-called ‘middleman’ or ‘bicholiyas’. These retailers promise to purchase directly from the farmers and selling them to a consumer at lower prices. In this case, the farmer may get more e.g. Rs 3 per kg and sell at say Rs 8-9 per kg. The company will employ its own efficient transport system (to replace several small transporters with a handful), do away with the small wholesalers (which are likely to be replaced with larger ones), and completely do away with the persons like thela owners (one who rents his thelas), and the thelavalas, the end retailer, as described in the above example.

The other promises include the creation of about 1 Cr jobs, 30% mandatory sourcing from local manufacturers, and development of back-end infrastructure. The proposal also aims at allowing consumer comfort of buying everything under one roof at lower prices.

4. Impacts of FDI in Retail in various sectors in India

4.1 New Employment and Existing Small Retailers & Vendors

It is vital to know that 70% of the persons engaged in this economic cycle are either illiterate or literate below primary level. This essentially means that once displaced from their traditional means of livelihood, a large proportion of those will not find any place in the ‘promised’ pool of employment that this sector is promising to create.

As per 2010 statistics with $421 bil (~INR 22,50,000 Cr) revenue and 2.1 mn employees, Walmart generated more than $ 200,000 per employee. By contrast, the average Indian retailer had a turnover of only Rs. 186,075 (in 2001) while employing more.

There is no answer to the alternative means of livelihoods for millions (about 4 Cr) and their dependents. Will it not disturb this hornets’ nest? Will it not create further pressure on already tight economic condition of the country? Would government compensate this loss via increased taxation on the consumers for enjoying lower prices?

While the small retailers, wholesalers or any other ‘middleman’ put back the money thus earned into our own economy, these foreign investors will take back the profits earned to their home countries in the USA and Europe. This sounds very much similar to what East India Company did a few hundred years ago.

4.2 Back-end infrastructure

These larger retailers are supposed to invest in the development of back-end infrastructures such as cold storages, warehouses, and an efficient supply chain. This is surely a much-needed step in light of wastage of tons of farm produce. It is worth noting that in 2010 alone 58,000 Cr worth of food grains wasted on the account of poor storage facilities. Therefore, development of backend infrastructure is surely a need that the nation has to address it on priority. However, is to rely on FDI for such development an ultimate solution? How will our country with a diverse geographical landscape and lacking in basic infrastructure such as roads, electricity encourage foreign players to create warehouses at inaccessible locations?

4.3 Manufacturing Industry

By making 30% mandatory sourcing from local, government thinks that it will boost our manufacturing industry. However, the big retail companies have already raised concern on this 30% rule. The key reasons are:

  • Big retailers will have to find ways to overcome low production capacity of small players
  • It will be too costly to educate and train a large number of small suppliers. In that case, how will we ensure low prices to end consumers
  • Foreign players typically operate by importing goods and partnering with a few large producers who can meet their demands of uninterrupted supply
  • They will have difficult times searching for goods they need
  • Why will they source items locally at a higher cost when cheaper alternatives are available at lower cost from countries like China?
  • Practices such as purchasing items from companies who themselves have imported from other countries may come into existence.
  • India’s manufacturing sector is constrained by high capital cost, stifling regulations, poor infrastructure. This makes it unlikely that our manufacturing sector can supply the appropriated quantity of right quality at the competitive price.

If companies, after entering our country, find it difficult to source locally, they will exert strong pressures on government to remove this condition. With deep pockets and extraordinary negotiating powers, these giants are sure to win. The loss would be ours; our small sale industries will not survive the stiff competition from cheaper goods imported from other countries. A point worth noting that the US retail giant Walmart alone imports from China about 15% of the total goods imported in the USA.

Being a signatory to WTO & TRIMS, India cannot impose sourcing restrictions to foreign investors. 30% sourcing restriction will be against the sections 4 and 5 of GATT and section 2 of TRIMS. India will have to treat foreign goods at par with local products. The government is misleading people by promoting this clause and not telling the truth.

4.4 Farmers and Agriculture

The government claims that the farmers will be the largest beneficiary of this policy. It shall not be denied that the farmers must receive good returns for their hard work and we must take all necessary steps to ensure good living conditions for farmers. However, one needs to ponder over the following points before concluding anything:

Foreign retails will give better prices to the farmers – Why? And how long? Studies indicate that in Mexico and Central America, Walmart has pushed down the prices paid to the farmers.
As proposed when this supply chain is cut short, farmers will have no other option but to sell to these large retailers. In that situation, will these players not push farmers for lower prices as was done in Mexico and Central America?

These retailers may force farmers in contract & selective farming – that is farmers will be able to cultivate the crops that these players wish to sell thereby creating an imbalance. For example, when these companies find that cotton can be cheaply produced compared to pulses, they will force farmers to cultivate the only cotton. In such scenario, prices of the pulse will naturally go up. Who will suffer?

Are these retailers, however large they are, in a position to engage with a large pool of farmers directly? Some of the large companies currently operating in this segment have already raised concerns on this issue. This is likely to reinforce the concept of middleman, maybe in a different form. In that case, the whole purpose will be lost.

4.5 Consumers

It is being claimed that the after the farmers, the consumers will benefit the most. The consumer will be able to buy everything in the air-conditioned environment under one roof. Cost of the items will go down while the quality of products will improve. It shall not be denied that the as consumers, we have the right to enjoy shopping and purchase what we desire at lower prices.

However, the reality is different from what is being sold to the consumers. Large retailers like Walmart typically offers heavily low prices, in the beginning, to wipe out the competition. Once the monopoly stage is achieved, they start selling at high prices while purchasing at low prices? Would we be in a position to reverse the trend at that point in time? With high bargaining powers, they eventually put pressure on State finances, through tax-breaks, effective outsourcing models to kill production jobs, and demands for increased investments in social initiatives by Governments due to job displacements.

As a country of 1.21 billion, we need to first fix our priorities. The livelihood of millions is more important for us or the consumer comfort?

5 Experience of Foreign countries

It may bring perspective to this study if we look at the experience of a number of foreign countries which allowed FDI in retail or where these large retail stores are operating.

5.1 Thailand

Thailand allowed FDI in retail in the year 1997
In 5 years, about 60% of small stores shut down

5.2 Britain

After allowing FDI, between 1981-91 number of independent stores fell by 50%

5.3 Malaysia

After the opening of supermarket chains, vegetable suppliers dropped from 200 in 2001 down to 30 in 2003.
Malaysia has now been forced to enact new laws to check the prolific expansion of the new foreign malls and hypermarkets.

5.4 United States

85% of USA retail sector is organized and employs the measures that our government dreams to see in India after allowing FDI in retail. However, conditions of farmers in the USA are not very encouraging. How will conditions of our farmers be any different? Majority of our farmers are uneducated or educated below primary level compared to the educated and tech-savvy US farmer.

According to a study in the US, before 1950 a farmer used to earn 70 cents on every $1 product that he sold but after the retail revolution in 2005, these earnings skydived to just 4 cents.
Studies have shown in the US (and in Europe) that despite the boom in the retail sector and growth of the food processing industry, the agricultural sector is one of the biggest recipients of subsidy by the government. Why does the USA subsidize their farmers to the extent of US$400 billion (~INR 20,00,000 Cr) annually? This is a staggering Rs 5,000-Rs 6,000 Cr daily.
Walmart is the largest retailer in the world with $ 421 bill (~INR 22,60,000 Cr) of revenue in 2010. Its revenue is almost equal to the size of India’s entire retail sector. It has about 8500 stores worldwide with about 4000 alone in the USA and employs about 2.1 mil (21 lakh) people worldwide.

The entry of the trading giant, Walmart, led to the closure of 40,000 US factories between 2001 and 2007, resulting in millions of people out of their jobs. Between 1992 and 2007, the number of independent retailers fell by more than 60,000.

The growth of Walmart has resulted in decreased wages, the shrinking middle-class and increase in working poor. Communities lost their local retailers and there was less demand for other services such as accounting, and graphics design.

On June 30, over 10,000 people, shouting “Walmart = Poverty”, marched through Los Angeles, America’s richest city, against Walmart stores. “Say-No-To-Walmart” is an ongoing movement all over the United States.

5.5 China

China is an economy thriving on its manufacturing sector; India needs to do a lot in this sector.
China first developed its manufacturing capability and then identified ways to sell its products.
Walmart alone imports about 15% of total Chinese import into US.

Therefore, China not only boosted its manufacturing capacity, it also identified means via FDI in retail to sell its products in its own country as well as in the foreign countries.
Chinese goods imported into US by Walmart alone comprise about 15% of total US imports. India thrives on service sector with 57% contribution. Therefore, India is unlikely to get benefits that China could reap by allowing FDI in retail.

6. Alternatives

The biggest challenge that India currently faces is not the lack of funds but the lack of effective governance. Corruption is at its peak. An immense amount of black money is stashed overseas. Due to wrong economic policies, and lack of governance, high inflation is prevailing. Farmers do not have easy access to cheap credit. Farmers do not have access to basic facilities such as roads, electricity and water for irrigation. There is dearth of cold storage and warehouses. Every year, farm produce worth thousands of crores is being wasted. Current government does not have its priorities right.

While FDI in retail promises to solve some of these issues, it is unlikely to address the more fundamental issues pertaining to India’s economy. The immediate need is to curb the corruption in the governance system, and bring back the black money. We can invest the money thus available in the development of this nation rather than begging in front of foreign investors. The CWG scam alone amounted to 77,000 crores. This amount could have been utilized in building thousands of warehouses and cold storages across the country. We could have saved tons of grains from being wasted and could have extended easy credit to farmers. If we account for all the other scams of past few years and also add the black money stashed overseas, we will have sufficient funds to change the face of our nation. We need not surrender in front of foreign multi-national powers which are trying to gain access to our invaluable resources. They are looking for alternative markets as they face revolts in their native countries due to unethical business practices and pushing poverty.

References:

1. FDI in India’s Retail Sector More Bad than Good? By Centre for Policy Alternatives
2. 30% sourcing promise clashes with WTO norm – Hindustan Times – December 06, 2011
3. Business Line _ Opinion _ Retail needs more than FDI – September 28, 2012
4. Business Line _ Opinion _ The dubious benefits of FDI in retail – October 2, 2012
5. Business Line _ OTHERS _ STATES _ Foreign direct investment in retail to benefit rural economy, says CII-SR – November 26, 2011
6. Business Line _Fetters on FDI holding back Indian retail, say analysts – April 6, 2011
7. Indian retail sector to grow to about $900 bn by 2014: PwC – Feb 3, 2011
8. FDI in retail is another way for some to make money: VK Singh – October 6, 2012
9. Economics Journal: Who’s Afraid of Wal-Mart? – December 5, 2011
10. Experts divided on benefits of FDI in retail to farmers – Business Standards – Sep 17, 2012
11. Economics Kills – Sourav Roy – December 5, 2011
12. FDI IN INDIAN RETAIL SECTOR:ANALYSIS OF COMPETITION IN AGRI-FOOD SECTOR – April-May 2012
13. FDI in retail – Devinder Sharma – Jagran – 06 Oct 2012
14. ‘Reform’ at nation’s cost – Indian Express – S Gurumurthy – Sep 20, 2012

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