The FDI Factor

Written by Amarpal S Chadha | Updated: Jun 28 2009, 08:32am hrs
The Indian retail market is undoubtedly one of the most attractive emerging market destination for investment. Foreign Direct Investment (FDI) in retail was expressly prohibited in 1997 and was permitted later in 2006, in the form of single brand retailing with up to 51% foreign investment with prior government approval. As of today, FDI is also allowed to the extent of 100% through wholesale cash-and-carry model. Other forms in which FDI is present in India is manufacturing and retailing and multi-level marketing models.

As FDI is prohibited in multi-brand retail, lot of multi nationals have forayed in India through a franchise model or a wholesale cash-and-carry coupled with franchise model. The franchise model has been one of the most prevalent and successful formats of retailing in India. Global players like US-based Tommy Hilfiger, Netherlands-based SPAR International, Argos, Debenhams, Costa Coffee, Dominos Pizza, Thank God its Friday, Ruby Tuesdays, Subway, Mothercare and McDonalds have become forerunners in India through the franchising route.

In a pure franchise model, the franchisor does not make any investment in the franchisees business. Under this model, the franchisor is entitled to get franchise fee for providing access to foreign brands and providing know-how on the methods of distribution, merchandising, packaging and promotion. However, there are other forms of franchise models which are prevalent in India such as management contracts, management franchise and joint venture arrangements which might involve some investment from the franchisor in terms of interiors, equipments etc.

Till the government does not open FDI in multi brand retail, it appears that the franchise route will continue to be one of the most favoured routes for foreign companies to establish their brands in India. The typical industry sectors witnessing the growth of the franchise model are IT education, followed by IT enabled services, business services, professional and vocational education, retailing, entertainment and healthcare.

The Indian government has not been inclined on opening FDI in retail. The rationale for not encouraging FDI in retail is mostly to protect the unorganised players.However, one cannot undermine the advantages which organised retail (with or without FDI) can extend to the economy in the form of increased employment opportunities, reduction in prices of goods, improvement in supply chain, reduction of wastages etc.

There have been recent developments on the policy front by the introduction of Press Note 2, 3 and 4 of 2009. Press Note 2 prescribes the manner of calculating FDI in a step down subsidiary. It also suggests that if an Indian investing company is owned and controlled by residents (ie resident Indian citizens or Indian companies owned and controlled by resident Indian citizens), any downstream investment made by such investing company will not be treated as FDI. A prima facie reading seems to suggest that by adopting the above structure, indirect FDI can be made possible in the step down subsidiary which is into multi brand retail. As the guidelines illustrated in Press Note 2, 3 & 4 are not clear, a clarification in this regard would be helpful in order to have clarity on FDI in multi brand retailing.

To conclude, even if the Government does not open FDI in retail, there is a need to encourage organised retailing in India. Organised retail with its inherent benefits will contribute significantly to the countrys GDP.

The writer is Senior Professional, Retail & Consumer Products Practice, Ernst & Young. These are his personal views