The New Year has kick-started with good news on economic policy. On January 10, the government notified its earlier decision of permitting 100% foreign direct investment (FDI) in single-brand product retail trading. But attached to this permission are conditions that are bound to present implementation challenges and include a two-step application process that can be unnecessarily time consuming. Notwithstanding this, it is a laudable policy measure and arguably the first step towards eventual opening of the sector to multi-brand retailers.
At present, 100% FDI under the automatic route is permitted in wholesale cash-and-carry trading; 51% FDI, with government approval, is permitted in single-brand product trading; while no FDI is permitted in multi-brand retail.
Under the new policy, 100% FDI has been permitted in single-brand retail, with government approval that will allow brands that are sold under a single brand even in countries other than Indiato enter the lucrative Indian retail market.
But it comes with a condition: “mandatory sourcing of at least 30% of the value of products sold would have to be done from Indian small industries/village and cottage industries, artisans and craftsman”. Small industries have been defined to mean “industries that have a total investment in plant and machinery not exceeding $1 million at the time of installation, without providing for depreciation”. Interestingly, the recent notification states that “if at any point in time, this valuation (of plant and machinery) is exceeded, the industry shall not qualify as a small industry for this purpose”, consequently compelling companies to look for alternative sources. The new policy also stipulates that “compliance of this condition will be ensured through self-certification by the company, to be subsequently checked by statutory auditors, from the duly certified accounts, which the company will be required to maintain”.
The conditions imposed raise questions on the frequency and time intervals within which the self-certification and statutory audit need to be conducted. At a practical level, businesses require a gestation period to mature, start earning a steady stream of revenue and to gather brand loyalty. In such circumstances, a quarterly, biannually or even an annual reporting may not be commercially viable. Is the government’s intention, therefore, that the self-certification and statutory audit will be over, say, a 3-to-5-year period or over the life of the business? In either circumstance, any extended time period presents its own set of procedural challenges, since the company alone will have knowledge of its actual sales and sourcing, and the extended time period can give it enough room to manipulate records, if it so desires.
Notably, almost any form of self-compliance places a high level of trust on its subjects. And while doing so is good practice, history stands witness to the fact that most forms of self-governance lead to loopholes to doctor paper compliances. And who is expected to regulate the statutory auditors that will audit the certified accounts that the company is expected to maintain? By no means is the suggestion that some super-regulator be created to monitor compliance. But it would have been helpful if the policy, at the very least, could have spelt out the consequences of non-compliance, since the threat of losing one’s operational licence or government approval would have instilled a greater sense of sincerity towards the self-certification process prescribed.
Another condition that raises questions is whether the requirement is to only mandatorily source “30% of the value of products sold” or whether the expectation is that the products sourced from the Indian small industries must also be sold? It’s obvious that it would make no business sense for companies to take on their books dead inventory. But equally so, what can a high-priced designer brand expect to source from the domestic small-scale industry that it can sell alongside its uber luxury products housed in fancy malls or hotel outlets where the return on each inch of space is strategically calculated!
To clarify, the suggestion is not that domestic small scale industry products are by any means of poor quality. On the contrary, the products manufactured by Indian cottage industries, artisans and craftsman are much sought after in overseas markets and are a great value for money. But what can, say, a Hermes get manufactured from a domestic enterprise that has a total investment of under Rs 5 crore in its plant and machinery that it can sell alongside its famous Birkin bag!
And if the international brands are capable of devising a business model where products sourced from domestic small scale industry are capable of being sold alongside the high-priced luxury goods, it is not long before an altogether different set of debates starts on the inequality in the sharing of profit margins between the international brands and their domestic sources. Also, if international brands are able to find a domestic small scale industry that meets their quality standards, as a result of which the domestic industry makes profits that it wants to reinvest in its processes, will not the condition that if at any time the total investment in the plant and machinery exceeds Rs 5 crore act as a deterrent? That unit then risks either losing its status of being a ‘small industry’ or losing its client, since sourcing from them will no longer qualify as sourcing from small industry.
In conclusion, while investors have been hoping for more than just opening up of single-brand retail to 100% FDI, let us take note that this is a step in the right direction. Like any new regulation, this policy also has its own set of challenges that will hopefully get resolved and ironed out in due course. Those in support of opening upIndia’s retail sector are not wrong to expect that things can only look up from here and that time may not be far when multi-brand retail may also be open to FDI. But before we get there, let us ensure that we clean up the bath water, to avoid any possibilities of the baby getting thrown out inadvertently.
FIRST PUBLISHED IN THE ECONOMIC TIMES ON JANUARY 14TH, 2012