Column: Triggering capital flows

Updated: Dec 3 2013, 03:37am hrs
Two vital policy decisions are expected from the ministry of finance in the next few days. These are decisions where the Centre has already taken initial steps. And now, the critical opportunity of moving forward decisively is here.

The first of these relates to the policy around foreign investment in e-commerce. At present, FDI in B2C e-commerce is prohibited. Even as the government opened up physical retail last year, the e-commerce animal was not tackled. It was felt that this model, with its ubiquitous presence, is too complex to handle. The safer bet was just to let policy steer clear of it. As we, however, address this admittedly complex issue, it will be useful to consider why FDI in this sector is prohibited in the first place. The prohibition arises from the notion that FDI in any form of retail tends to disrupt the local economy and impact the livelihood of small traders. It creates an uneven playing ground, where foreign investors have access to much larger pools of capital. This rationale is precisely the reason why the physical retail policy imposes onerous obligations on foreign investors.

But e-commerce is different, for many reasons. One, the operational model is sharply distinctconsumers buy online, without touching and feeling the actual product and without having walked into a physical store.

Second, you cannot walk in, buy and walk out with what you boughtyou get delivery in a few days. Globally, online retail has meaningfully developed in product areas that are only a subset of what physical retail markets offer. Data around this fact must be closely considered while evaluating whether online retail causes any disruptive impact.

Third, in India, where we are definitely not the best at building physical infrastructure, online retail meets aspirations of small-town India in the same way as mobile telephony empowered our rural society. We must not underestimate this societal empowerment.

Fourth, large-scale capital deployment always has ancillary economies growing around it. Online retail will create new opportunities and modernisation in logistics, outsourcing, supply chain, etc, will make our basic economy more competitive.

Fifth, in a sense, we are examining this issue after it became fait accompli. If we were to look around and see the capital that has fuelled our online retail giants, one would see that 95% of that money is all foreign anyway. The only difference being that the structure is such; business activities do not fall under retail definition. And we are already seeing the benefits to the consumers, to the small vendors and SMEs, to the ancillary industries, arising from online retail. We should have the data by now to see whether there have been the kind of competitive or dominant impacts that we are bothered about.

I would stick my neck out to say that there is a clear and present opportunity for evolving a policy pronouncement that takes cognisance of these distinctions which allows meaningful (even 100%) foreign capital to flow in more freely, and yet is armed with safeguards to take care of any potential issues. Safeguards could include provisions relating to sourcing, mixing of online and physical multi-brand retail, relevant government-approval processes that evaluate competitive impacts, which could perhaps be the subject matter of another column!

I now turn to the secondunrelated but more technicalissue on the ministrys table: put and call options. The Companies Act and Sebi restrictions are gone. RBI relaxation is also imminent. RBI feels that options allow equity instruments to enjoy debt-like characteristics without having to comply with ECB guidelines. However, adding controversy is the issue that Indian companies have used these restrictions to deny their foreign investors contractually-committed liquidity. I think as long as pure equity returns flow to investors, there shouldnt be a problem for the investors or for the regulator. Thus, puts/calls may not be (mis)used as a tool for guaranteeing fixed returns, instead allowing only genuine monetisations.

A bunch of safeguards around these could be builtfair value exits are one. Monitoring the timing of exit another. DCF being peer-reviewed a third. The core point is if foreign capital must have some small element of being hybrid, we should not shy away. Let us take a few chances and see the actual experience on the ground.

Both of the above pronouncements might not be headline-grabbing but they have the potential to drive growth and trigger capital flowsthat is, if we are bold and get it right this time around.

Vivek Gupta

The author is partner, BMR Advisors. Views are personal