Parliament has approved foreign direct investment (FDI) in retail. However, the stringent riders seem to have wiped the smile off the face of multinational retail players. After a long-drawn discussion, the Government opened doors to FDI in multi-brand retail trading, but the conditions regulating foreign inflow have left foreign players undecided yet.

The welcome mat rolled out to foreign multi-brand retailers is embedded with a minimum investment requirement of $100 million. There is still ambiguity over whether this is supposed to be a bullet investment or a phased investment. However, as investment in retail industry often entails a high gestation period and the need for a phased rollout, it is envisaged that the investment too should be in phases. Also, when foreign players buy out an existing Indian multi-brand retail business to enter this lucrative market, it is hoped that the investment on the transaction would be considered towards meeting this minimum investment criteria.

Furthermore, retailers are required to invest 50 per cent of the total FDI in ‘backend infrastructure’ within three years of the first tranche of the FDI. The rider explicitly excludes expenditure on land cost and rentals from backend infrastructure. This will likely worry some players as the principal chunk of backend cost may comprise land cost/ rent of warehouses and cold storage spaces. Without these, retailers may find it challenging to meet the 50 per cent criterion.

The Government may consider including expenditure on land cost and rentals of backend infrastructure in meeting the 50 per cent investment condition or, at the least, clarify that backend infrastructure expenses include working capital expenses for backend infrastructure. It is known that while initial investment in backend infrastructure is high, the marginal expenditure on it when scaling up operations may not be as high. Accordingly, it may be suggested that the 50 per cent criterion should be applicable only to the initial investment by the foreign player and not on subsequent investments.

Many of the large foreign retailers already have backend facilities for their existing wholesale ventures. Now, their foray into retail may not necessitate new backend infrastructure. In such cases, there should be a relaxation as business exigencies may not permit further investment in backend infrastructure.

Under the policy, multi-brand retailers should source 30 per cent of manufactured/ processed products from Indian ‘small industries’ (with investment in plant and machinery not exceeding $1 million). Apart from worries over quality, the mandatory sourcing from ‘small industries’ would restrict the retailer in achieving economies of scale, consistencies in product range and technical specialisations. Also, with the sourcing condition, a big player looking at large investments would incur high costs towards training a large number of small suppliers, with the brand reputation at stake.

In the future, when the retailers look for expansion, it would be difficult to continue sourcing from small industries. Moreover, the very sourcing by the retailer would eventually lead to the ‘small industry’ outgrowing its stature and violating the condition. The solution perhaps lies in limiting the classification of a ‘small industry’ for a specified period of time.

Retailers also call for industry-wide consistency in FDI regulations. Just as the liberalisation of the 30 per cent sourcing condition in single-brand retail trading, multi-brand retailers too should be allowed to source 30 per cent from India — with a preference towards MSME, cottage, rural and handicraft industries — and not as a mandatory condition.

While e-commerce is steadily gaining ground, the regime makers have explicitly kept out foreign retailing investors from this segment. The e-commerce retail industry, growing at more than 50 per cent, is a huge attraction for foreign retail investors. They can now only hope that the Government would open the doors for FDI in e-commerce retailing or treat e-commerce as another service industry and allow 100 per cent FDI.

FDI in multi-brand retail has been widely hailed as one of the boldest moves by the Government, but its implementation calls for practical interpretation and relaxation of conditions in certain cases. Thus, foreign retailers may have to strategise their investments in India.

Paresh Parekh is Tax Partner – retail & consumer products, Ernst & Young

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