The Hindu Business Line : FDI in retail: More benefits than costs

THE debate on foreign direct investment (FDI) in retail is hotting up. Once again, the ruling Government and its allies are in sharp disagreement. What is the debate about?

The opposition to FDI in retail rests on several planks. One, the entry of large global retailers such as Wal-Mart would kill local shops and millions of jobs. Two, the global retailers would collude and exercise monopolistic power to raise prices and monopsonistic (big buying) power to reduce the prices received by the suppliers.

Hence, both the consumers and the suppliers would lose, while the profit margins of such retail chains would go up. Three, it would lead to lopsided growth in cities, causing discontent and social tension elsewhere.

Before evaluating these apprehensions, it should be recognised that even the Left is not against all kinds of FDI in retail. It is in favour of selectively allowing FDI in food, dairy and grocery segments of retail trade.

In other areas such as readymade garments and various industrial consumer goods, it would allow only big domestic retailers to compete with small local kiranas. Even when FDI is to be allowed in retail food and grocery sectors, it would like to put a cap on foreign ownership.

In other words, foreigners — if they want to enter — will have to take local partners to start with. Once the local partners and other local players learn by doing, the FDI cap can be raised gradually. Foreigners can be allowed to set up 100 per cent foreign-owned retail chains only after the local players are able to muster enough capital, experience and expertise to compete with established global giants.

It is interesting to note that the Left approach to the issue broadly follows the Chinese model. China first allowed FDI in retail in 1992. The initial FDI cap was 26 per cent. It took China 10 years to raise the limit to 49 per cent. The 100 per cent foreign-owned retail stores were allowed only from 2004.

Further, foreign chains were initially permitted to set up stores only in a few select cities. Local retailers were officially encouraged to become big by mergers and acquisitions so that they would be in a position to compete with big global players. In other words, China provided infant industry protection to domestic retailers, which was gradually reduced as the local players gathered strength.

The supporters of FDI in retail see many advantages. The biggest benefit, according to them, would flow from higher exports. They point to the Chinese experience.

The global retailers taken together buy about $60 billion of goods each year from China for exports. Contrast this with India where less than $1 billion of exports are accounted for by global retailers (mostly metro dairy farm). Clearly, the scope of exports through the global retailers is enormous, indeed.

However, one may ask: Can not Wal-Mart or Carrefour source products from India, even if they are not allowed to set up stores here? Though in principle that is possible, in reality, things do not work out that way. A global chain would buy large quantities for exports on a sustained basis only when it establishes a close linkage with the local market and suppliers. This happens after they open local stores.

By being continuously close to local suppliers and customers, they are in a better position to control and monitor the entire supply chain including the designing of products, the quality of inputs, the manufacturing process, the quality of output, the standardisation, labelling and packaging, transportation, warehousing, the distribution network, changing product mix quickly in response to changing global fashions and establishing the right kind of captive suppliers who would not be selling to their competitors.

The supply chain and the infrastructure, which they would develop for their local stores, would yield significant cost economies when it is also used to procure supplies for their global needs. That is why Wal-Mart sources some $18 billion of goods from China for their global operations. But this happened only after it was allowed a substantial presence in the Chinese local retail market.

How about the potential job loss in local kiranas? True, small retail stores are an important source of jobs, providing about 7 per cent of the total employment in India. Moreover, they are providers of employment of the last resort. Anyone without a job can set up a local retail outlet. However, India is not an integrated homogeneous market; it is a hierarchy of markets catering to people of many different income levels and tastes. For example, both Sony and Santosh can coexist, catering to market segments.

Entry of sophisticated branded products affects the unbranded mass market only marginally in a vast poor country such as India. Moreover, in malls where the large retail chains set up their stores, typically, there will also be many small shops which will attract people.

Further, the street-corner shops will have some advantages over big stores located many miles away in shopping plazas. In India, transportation and parking are big problems for people who want to visit shopping malls.

For them, it is more convenient and cost-effective to purchase many of their daily requirements from the neighbourhood stores, especially as these establishments stock goods that are in particular demand in the locality. Hence, the pop-and-mom street corner shops can very well survive.

The benefits from greater exports would be particularly high in the farm sector. Right now, there is a tremendous amount of wastage and value loss of agricultural products due to lack of storage, refrigeration, transportation and processing facilities. As a result, farmers' price realisation remains low while the consumers in the cities end up paying a high price. Given the fiscal problems of the government, it is too much to expect it to build the required infrastructure.

To the extent the large retailers establish a direct linkage with the farmers by cutting out many layers of middlemen, develop the processing facilities and export the products to meet their global requirements, farmers would get better prices and bigger markets while the consumers would benefit in terms of lower prices, better quality and greater variety. The resultant rural prosperity may open up markets for other industrial goods and help a more balanced regional development as also job creation in other sectors.

Similar gains would flow from higher exports when the global chains are allowed in other sectors such as readymade garments. As for monopolistic pricing practices, the best safeguard would be in permitting all global chains to set up shops. The competition among them (as has happened in the automobile industry) would ensure better prices for consumers and suppliers alike.

Thus, the benefits from higher exports are likely to offset any direct job loss in the local kiranas as result of competition from big global retailers. Anyway, if the domestic big players are allowed to operate, the job loss problem for the small shops would remain, while the benefits from larger exports would not be there. So, clearly, if big players are to be permitted in retail, this must extend to FDI. Otherwise, the full range of benefits will not be realised.

Of course, some lead time can be provided to the local players to consolidate their position before they face full-fledged competition from established global players. But, then, temporary protection should be really temporary. The Government must make a clear commitment to the time-frame over which protection from foreign competition would be removed gradually.

(The author is Professor of Economics, Indian Institute of Management, Calcutta, and Visiting Professor of Economics, University of Rochester, US. He can be reached at alokray15@yahoo.com)

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