India opens up to foreign ownership of multi-brand retailers

Foreign retailers wanting to invest in India have been faced with a number of changes to the legislation since foreign direct investment (FDI) was first permitted for single-brand retail in 2006. In November last year, the government announced changes to open up the market to FDI in multi-brand retail. However, in the face of fierce opposition from various stakeholders and opposition parties, the government deferred its decision to introduce the changes.

However, in a press note dated 20 September 2012, the government confirmed its proposed changes by allowing FDI in multi-brand retail trading up to a certain level and subject to certain conditions. It has also announced a dilution in the sourcing and brand ownership requirements for FDI in single-brand retail.

Single-brand

As reported in Law-Now single-brand retailers (such as Ikea and Marks & Spencer) had benefited from a decision of India’s Department of Industrial Policy and Promotion (DIPP) in January 2012 to raise the FDI limit from 51% to 100%. This was (and still is) subject to a successful application to the government for investment approval, and adherence to various terms and conditions.

However, the requirement to source at least 30% of the value of products sold from Indian ‘small industries, village and cottage industries, artisans and craftsmen’ cast doubt on the extent to which foreign retailers would profit from the relaxation for single-brand retailers. ‘Small industries’ are defined as industries with a total investment in plant and machinery not exceeding US $1 million. That valuation refers to the value at the time of installation, without providing for depreciation.

The government has recognised that this posed a large hurdle for many single-brand retailers and has now relaxed the sourcing condition. Although 30% of products must be sourced locally, it is now only preferable rather than mandatory that this is from small and medium enterprises. The quantum of domestic sourcing will need to be certified by the Indian entity carrying out single-brand product retail trading in India and verified by its statutory auditors.

A further restriction to be lifted is one that permitted only the owner of a foreign brand to invest in an Indian company undertaking single-brand retail activity of its merchandise. Following the change in legislation, any non-resident entity with rights to use the brand can make the investment. This is subject to permission from the brand owner and an investment by only one non-resident entity per brand.
Multi-brand

On 20 September 2012, the DIPP revised its position on multi-brand retail trading with immediate effect.

Under this new policy, a 51% FDI can be made in a multi-brand retailer in India subject to a successful application to the government for investment approval, and adherence to the following conditions (among others):

• the minimum amount that the foreign investor may bring in as FDI is US $100 million;
• at least 50% of the total FDI should be invested in back-end infrastructure within three years of the investment. Back-end infrastructure includes processing, manufacturing, and distribution, among others, but does not include land cost and rentals;
• retail outlets should only be opened in cities with a population of more than 1 million people as per the 2011 census (Population Threshold). For states or union territories that do not have cities meeting this population threshold, retail outlets may be set up in cities of the state or territory’s choice (preferably the largest city). In either case, retail outlets may also be set up to cover an area of 10 kilometres around the municipal/urban agglomeration limits of such cities;
• retail outlets should only be opened in states and union territories that have agreed or will agree to allow FDI in multi-brand retail. This list currently comprises: Andhra Pradesh; Assam; Delhi; Haryana; Jammu & Kashmir; Maharashtra; Manipur; Rajasthan; Uttarakhand, Daman & Diu and Dadra and Nager Haveli;
• multi-brand retail trading companies with FDI are not entitled to be involved in e-commerce retail activities; and
• multi-brand retailers must source a minimum of 30% from Indian ‘small industries’ that have a total investment in plant and machinery not exceeding US $1million. (Note that this is now only preferable for single-brand retailers.)

The above policy change will be reflected by amendments to the Consolidated FDI policy, issued on 10 April 2012 by the DIPP.

What do these changes mean for foreign retailers looking to expand into India?

The relaxation in the FDI restrictions is likely to be of interest to multi-brand retailers such as Tesco, Wal-Mart and Carrefour, who may wish to invest directly in India. The Indian retail market is currently estimated to be worth $450 billion. The ability to own up to 51% of their investments will enable these global giants to set up with a local partner and sell directly to consumers for the first time.

The ever increasing number of consumers in India, and their falling average age and rising disposable incomes, has inspired a retail boom that should continue with the help of FDI. The total Indian retail consumption is expected to grow from $400 million to $1 trillion in seven to eight years.

Foreign multi-brand sales outlets may only be opened in the larger Indian cities (those meeting the Population Threshold) but due to the continued urbanization of the population, retail investors have a number of qualifying cities to choose from. Further, as this is enabling legislation, individual states and union territories not listed above have the freedom to allow FDI in multi-brand retail. If the move is a success, foreign investors can only hope that more sign up.

For single-brand retail, the relaxation in the 30% sourcing condition from a mandatory requirement to only being preferable ought to allay the fears that have resounded in the industry since January. Ikea has already applied to the Indian government for approval to develop its stores following years of lobbying to allow full ownership of single-brand retailers. The company indicated in the Financial Times that it could invest up to $757 million in the first stage of its plan, and that its total investment could reach $1.9 billion over the next decade.

If the changes are not sufficiently attractive to foreign retailers wishing to enter this market there is another option. 100% FDI is allowed for cash & carry wholesale trading in India, subject to various conditions. This has already enabled multi-brand retailers, such as Wal-Mart, to gain a foothold in India.

Other issues in entering the Indian retail market

In spite of the opening up of the retail sector, foreign firms looking for a share of India’s projected growth will be faced with a number of the infrastructural challenges associated with a rapidly developing economy. One such issue, which will directly impact entrants to the retail sector, is the inefficiency of the distribution network due to a lack of storage, refrigeration and transport facilities.

These inefficiencies have added to the inflationary pressures on food prices and may impact on the country’s growth momentum. The trickle down effect of FDI, aided by the condition for multi-brand retailers to ensuring that at least 30% of the foreign firm’s produce is sourced from small domestic firms, should help to tackle these infrastructural issues. Finally, economies of scale exploited by large multinationals could contribute to a downward trend in food prices.

Consequently, foreign retailers will need to keep on eye on all the relevant developments in India, not just those associated with a liberalisation in FDI. Only then can household names such as Ikea and Tesco make an informed decision about whether to enter this market.

Contact us

CMS Cameron Mckenna works closely with Khaitan & Co, the leading Indian law firm, with offices in Mumbai, New Delhi, Kolkata and Bangalore, on advising foreign retailers who wish to enter the market. We are very grateful to Khaitan & Co for allowing us to use their newsletters to prepare this briefing note.

If you would like to discuss entering the Indian market, please contact Helen Johnson, Head of Retail, Bill Carr or Richard Price, from our India desk, or your usual CMS contact.