FDI in multi-brand retail: States could be the deciding factor

State governments will have a big say in whether the international retail giants are able to set up shop or not through the foreign direct investment (FDI) route and even when they do, it will take 5-10 years for the largest players to put up even a dozen stores particularly in the Cash & Carry segment.

CII National Retail Committee Chairman and Aditya Birla Retail CEO Thomas Verghese said potential entrants into the retail sector required 35 licences to set up a super market and 43 licences to set up a hyper market, all granted by the States. “To date, 11 States are potentially opposing FDI in retail, so clearly, we will look at the progressive State governments and even if there are a few States that are in favour, international players will come in.''

Reacting to fears that smaller shop owners will lose livelihood with the entry of the multinationals, Mr. Verghese said, “Over the last five years, modern retail's proportion in the total Indian retail sector has grown from 2 to 7 per cent, growing at 24 per cent annually. Over the same period though, smaller ‘kirana' shops have grown at 10-14 per cent. The larger kirana shops closing down has less to do with the entry of modern retail but more to do with the younger generation owners choosing not to remain in the business.''

Crisil estimates

Rating agency Crisil estimates FDI inflow of $2.5-3 billion over the next five years in multi-brand retail. The food and grocery (F&G) vertical could attract a larger share of the likely FDI inflows. The clause specifying 50 per cent investment in back-end infrastructure especially aligns with the commercial requirement in the F&G segment. F&G accounts for two-thirds of Indian retail sales, but has organised retail sales of only around 2 per cent. “To improve profitability in the F&G segment, retailers need to control their supply chain costs and build scale,'' said Ajay D'Souza, Head, Crisil Research. “Every percentage point reduction in supply chain cost and resultant gain in operating margin can improve equity internal rate of return of an F&G store by 250-300 basis points. Foreign retailers, with their access to capital and technology, are well placed to leverage this opportunity.'' The retail sector requires heavy investment and despite FDI being permitted in back-end infrastructure ten years ago, no significant player came in. Indian firms have built back-end infrastructure but do not have the wherewithal to expand. Foreign players will not come here if the front-end is not allowed and need assurance that presence in the whole chain would be allowed.

“The aggressive growth plans of leading Indian retailers, which are under pressure due to increasing debt stock and moderation in customer footfalls in the current year, will get a strong boost from the availability of capital. However, for smaller and regional retailers, the scale of operations and control over costs will determine their ability to weather pressures of aggressive expansions by large retailers,'' said Anuj Sethi, Head, Crisil Ratings.

The FDI proposal offers good prospects for large established Indian retailers. FDI would enable these players to attract capital for driving their expansion plans and in addition, benefit from scale, cost efficiencies and technology brought in by foreign retailers. The FDI proposal is likely to catalyse joint ventures between Indian and foreign organised retailers. Depending on whether they buy into existing retail chains or set up new joint ventures, the share of foreign retailers in multi-brand organised retail will remain moderate.