The Indian government suffered a political setback in early December when it was forced to shelve its proposal to further liberalize foreign direct investment (FDI) in India’s retail sector. The cabinet of the Congress party-led coalition had proposed rules that would allow 51% FDI in the multi-brand retail segment, versus zero previously, and 100% FDI in single-brand retail, compared with the previous limit of 51%.
The proposal would have allowed foreign multi-brand retailers such as Wal-Mart Stores to have a majority stake in Indian businesses and open supermarkets in India, and Indian multi-brand retailers such as Pantaloon to attract foreign investment. Similarly, single-brand retailers such as Louis Vuitton and Nike could have owned 100% of their Indian businesses, instead of a maximum of 51%.
Good time for reform
The proposal to liberalize the retail sector in India was expected to stimulate foreign investment in India at a time when overall foreign direct investment is down (it fell more than 25% to US$29.4 billion in the year ended 31 March 2011). Moreover, estimated gross domestic product growth for 2012 has fallen to 7.5% from 9% earlier, and the Indian rupee has recently weakened to record lows against the US dollar.
Liberalizing India’s retail market could also upgrade India’s supply-chain infrastructure, increase investments in commercial real estate development, stabilize prices that farmers can obtain for their produce, and lower prices for consumers, thereby curbing inflation.
Much of the additional foreign capital from liberalizing the retail sector in India would likely benefit the operators of large local retail store chains. An indicator of this was a significant increase in the share prices of publicly listed Indian multi-brand retailers. In the day after the proposed liberalization was announced, the shares of India’s leading retailers jumped, in some cases by more than 15%.
A plunge in these prices after the reforms were put on hold reaffirms the expectation that homegrown retailers would benefit from the reforms.
The implementation of the proposed rules could stimulate capital markets activity. For example, it could encourage publicly listed retailers to access the international capital markets though instruments such as global depositary receipts or foreign currency convertible bonds. Similarly, these companies could attract international investment through the qualified institutional placement regime.
The rules could also spur private equity investments in unlisted Indian multi-brand retailers, and initial public offering activity further down the line. Merger and acquisition opportunities could also be created, for example as international supermarket chains seek to acquire a controlling stake in Indian multi-brand retail companies.
Despite the potential benefits of liberalizing the retail sector, the politics of India’s coalition government resulted in a national debate that has delayed indefinitely the implementation of the proposed rules. Opponents of liberalization make populist arguments that link retail FDI to deepening inequities of Indian society, citing the adverse impact that international supermarket chains will have on small retailers in India.
These concerns may be exaggerated considering the minimal impact national Indian supermarkets have had on small retailers in India. This view was voiced by the US ambassador to India, Peter Burleigh, who cited China as an example of a country that allows FDI in retail without diminishing the competitiveness of small traders and small merchants in villages and towns.
The Indian Ministry of Commerce has noted that between 1996 and 2001, while more than 600 hypermarkets opened in China, the number of small stores also grew from 1.9 million to over 2.5 million.
There are other potential economic benefits of India’s retail sector liberalization. First, increased investments in retail may increase the demand for shopping centres, particularly in smaller cities. This could significantly boost commercial real estate development and increase investment in a sector that recently has been starved of capital.
Second, international investment could drive modernization of India’s supply chain infrastructure, resulting in cost efficiencies that would help keep food prices in check and curb inflation. Third, FDI in retail could generate employment gains and benefit the agriculture sector in India by stabilizing income for farmers.
For all of the reasons discussed above, many hope that the political will can be mustered to implement the proposed liberalization of the retail sector in India. From the perspective of international law firms advising on cross-border transactions involving Indian companies, this could stimulate cross-border M&A and international capital markets activity.
Stephen Peepels, a partner in the corporate group in Hong Kong, heads the US capital markets team for Asia. Timothy Franklyn is a senior associate in the corporate group in Hong Kong. DLA Piper is the world’s largest legal practice with more than 4,200 lawyers in 76 offices across 30 countries.