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India: Singh Doubles Down on Reform

A slowing economy gave India’s government the cover to push FDI in the retail industry

By Ashok Malik Created: October 5, 2012 Last Updated: October 5, 2012
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Indian traders cover their mouths with black cloth and handcuff themselves protesting against the Indian government's decision to allow foreign direct investment in the retail market during a rally in New Delhi on Sept. 27. (Manan Vatsyayana/AFP/GettyImages)

Indian traders cover their mouths with black cloth and handcuff themselves protesting against the Indian government's decision to allow foreign direct investment in the retail market during a rally in New Delhi on Sept. 27. (Manan Vatsyayana/AFP/GettyImages)

On the evening of Sept. 20, India’s coalition government took a momentous economic policy turn: It passed orders allowing foreign companies to set up retail stores in India.

Earlier in the day, a range of opposition parties, right and left, had participated in a nationwide strike against the move. The episode was telling and encapsulated many of the challenges and paradoxes that make up the story of liberalization and reform in India—where economic necessity and advance often clash with political imperatives and scaremongering by vested interests.

There are an estimated 12 million small and medium retailers in India, employing 40 million people. An additional 200 million are believed to be dependent on small kirana, corner or neighborhood stores for their livelihoods. These are numbers few politicians can ignore. From trade unions associated with the left to trader lobbies that have historically provided support to the socially conservative right, various interest groups have transformed retail protectionism into a holy cow and its dismantling among the most difficult reforms to undertake.

In 1997, India permitted 100 percent foreign direct investment (FDI) in cash-and-carry stores—foreign retailers could sell to India wholesalers but not directly to customers. In 2006, the first foreign-owned, single-brand retail store opened in India, with 51 percent non-Indian equity. In November 2011, the government of Prime Minister Manmohan Singh raised the single-brand FDI limit to 100 percent and allowed 51 percent foreign equity in multibrand retail, up from zero. There was uproar, not just from the opposition but within the Congress and Congress party—led United Progressive Alliance, UPA, led by the Congress Party. The decision was rolled back, damaging Singh’s reputation as a reformer.

Economic Opportunity

Last month, Singh finally bit the bullet, returning to the retail policy that he had been forced to put on the shelf 10 months ago. The slowdown in the Indian economy—India’s GDP growth averaged 8.5 percent a year from 2003 to 2011; for the April–June 2012 quarter it was down to 5.5 percent—gave him crucial political capital within a panicky Congress party. When the Trinamool Congress, the party that runs West Bengal State, withdrew support from the UPA government following the opening of retail, other state-specific parties supporting the move filled the breach. The government—and retail reform—was safe.

The Indian government has mandated that foreign retail chains will need to put 50 percent of their investment in the country in backend infrastructure.

Why does India need FDI in retail—and just how damaging will it be to existing small and medium retail?

In 2008, the Indian Council for Research on International Economic Relations, ICRIER, published a paper titled, “Impact of Organized Retailing on the Unorganized Sector.” The findings were included in a 2010 discussion paper on the topic and influenced the government. This discussion paper, in turn, defined the contours of the new FDI policy for retail.

“Given the relatively weak financial state of unorganized retailers, and the physical space constraints on their expansion prospects,” the ICRIER document noted, “this sector alone will not be able to meet the growing demand for retail. Hence, organized retail which now constitutes a small 4 percent of total retail sector is likely to grow at a much faster pace of 45–50 percent per annum. … This represents a positive sum game in which both unorganized and organized retail not only coexist but also grow substantially in size.” The rate of closure of small retail stores “on account of competition from organized retail” was found to be 1.7 percent per annum.

Benefits

While ICRIER did find “some adverse impact on turnover and profit of intermediaries dealing in products such as, fruit, vegetables, and apparel,” farmers were found to be big gainers: “Farmers benefit significantly from the option of direct sales to organized retailers. Average price realization for cauliflower farmers selling directly to organized retail is about 25 percent higher than their proceeds from sale to regulated government mandi [agricultural market]. Profit realization for farmers selling directly to organized retailers is about 60 percent higher than that received from selling in the mandi.”

The biggest beneficiaries of the entry of organized retail, the ICRIER report said, were consumers. Overall consumer spending had increased and prices for select commodities dropped.

Indeed in a country where some 40 percent of GDP comprises household consumption, it’s puzzling why politicians have never seen Indian consumers as a collective constituency. From sweaters stitched in Madagascar to stainless steel cutlery made in Vietnam, the deep and ruthlessly cost-efficient supply chains of international retail giants such as Wal-Mart can mean significant savings for middle-class shoppers in India.

For its part, the Indian government is selling the retail policy change as beneficial for farmers and as a curb on runaway food inflation, a phenomenon that’s pushed the price of milk, for instance, to double in the past five years. As it exists today, the Indian agricultural market essentially helps only a series of intermediaries. Farmers get a third—and in years of generous harvests as little as a sixth—of what the end-consumers pay for their produce.

Paucity of backend infrastructure such as cold storages leads to a third of fruits and vegetables grown in India perishing on the journey from farm to dining table. India, a country of 1.2 billion, has just over 5,000 cold storages, with a total storage capacity of 23 million tons capacity.

Robust investment from big retail—particularly foreign retail—is seen as an answer to these conundrums. The Indian government has mandated that foreign retail chains will need to put 50 percent of their investment in the country in backend infrastructure. Given the political opposition to the idea of a Walmart or a Carrefour setting up shop in India, the federal government has also given state governments the right to refuse permission to opening such retail stores in their jurisdictions.

That final clause is a concession to India’s deeply divided and provincialized polity, one where state and regional parties increasingly influence economic and foreign policy decisions taken by coalition governments in New Delhi. However, it also offers a route for further liberalization. Gujarat and Madhya Pradesh are both ruled by the BJP, the leading opposition party nationally. BJP governments in these states are officially opposed to FDI in retail. Yet, given their geographical advantages—coastal Gujarat has among India’s best ports and Madhya Pradesh is a massive heartland province right in the middle of India—these states could easily become logistical hubs for trans-Indian retail networks.

In West Bengal too, it’s likely that international retail chains will become customers, for instance, for the potato farmers of Arambagh, a few hours from the state capital of Calcutta. Indian-owned retail chains have already signed contracts with potato farmers there. As such, should international retail chains invest in backend infrastructure and make potato farmers in Arambagh more prosperous, it would enhance their leverage with the West Bengal government—and perhaps enable them to persuade local politicians to allow the opening of foreign-owned retail stores in Calcutta. If citizens of West Bengal sense that a foreign-owned retail store in a bordering state offers better products at cheaper prices, they might pressure politicians to change their policy.

This is perhaps what Singh had in mind when he inserted that “let the states decide” clause—recognition that as the locus of Indian politics and policy is moving to the states, so must the focus of business lobbying. As the prime minister said in a Sept. 21 television speech, “State governments have been allowed to decide whether foreign investment in retail can come into their state. But one state should not stop another state from seeking a better life for its farmers, for its youth, and for its consumers.” The test of the belief will come when the din of the street protests now roiling India dies down and producers and customers look for a better deal.

Ashok Malik is a senior journalist and columnist in New Delhi. He writes for a variety of Indian and foreign publications on, primarily, India’s political economy and foreign policy, and their increasing intersection. With permission from YaleGlobal Online. Copyright © 2012, Yale Center for the Study of Globalization, Yale University.

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