The FDI Conundrum
Samir Alam reports on how 100 per cent FDI in single brand retail could affect the Indian apparel market.
A report on the effects of 100 per cent FDI DI in Single Brand Retail on the Indian apparel rel market
In January of this year, the government began permitting 100 per cent Foreign Direct Investment (FDI) in single brand retail businesses. This marked a significant step by the administration in making India a more attractive investment destination for foreign funds. Under the terms of the new policy, foreign businesses seeking to invest in retail opportunities in India no longer have to seek government approval and can gain entry via an automatic route. This change has generated both positive and negative reactions from different parts of the Indian market for a number of reasons. However, its impact on the overall retail market in general, and the apparel market in particular, is still uncertain.
OVERVIEW OF THE CHANGES
Typically, FDI has been an essential source of monetary resource during India’s economic liberalisation process. However, while many developing nations across the world have opted to allow foreign capital interests to make a home
in their domestic economies early in their growth phase, India has maintained a relatively disciplined limit for outside players. We have seen examples of how developing nations have suffered through improper regulation of FDI in their economies, eventually allowing multinational companies to dictate terms as they acquire greater influence and control in these nations. Only in the last 20 years, has India proactively attempted to entice foreign investment money while maintaining control over essential sectors of the economy.
From 1997 to 2006, India practised the government approval route for most incoming funds and continued to attract an ever increasing inflow of FDI from around the world. However, the global recession during the 2007-09 period had a ripple effect, dropping FDI in India from USD 31.4 billion in 2008-09 to USD 25.83 billion in 2009-10, which fell further the year after to USD 21.38 in 2010-11. After the precipitous decline of over 35 per cent, the worst had passed and FDI inflows continued to rise in subsequent years from USD 35.1 billion in 2011-12 to USD 43.48 billion in 2016-17. The period from 2012-13 to 2016-17 has witnessed a Compound Annual Growth Rate of over 14 per cent in the total FDI for India, which is a promising sign for economic growth.
After years of careful consideration over financial sovereignty and monetary autonomy, India began slowly easing into allowing foreign funds to influence the Indian economy. For many of the early years, these investments were restricted to non-sensitive areas and only gradually were opened up to the wider market. With this year’s relaxation on the approval requirements for single brand retail, the Indian administration is effectively giving a boost to international brands in the retail sector to have an open field with regards to the Indian consumer.
FDI IN RETAIL
This trade-off between control and growth is a crucial compromise that is necessary to ensure economic growth in the current global landscape. However, given the ease of corruption and financial manipulation, it needs to be carefully navigated. The core objective has always been to enhance not only the scale of investment in the Indian industry but also the quality of investment. In the retail sector, the goal has always been to utilise FDI to create fundamental and structural enhancements such as the improvement of the supply chain and back-end retail setup. This would allow the nation a higher position in the global value chain in order to be more than simply a source of cheap resources and labour, and instead become a vendor partner for global players.
Previously, foreign players could only invest in single brand retail investments up to 49 per cent via
THE TRADE-OFF BETWEEN CONTROL AND GROWTH IS A CRUCIAL COMPROMISE THAT IS NECESSARY TO ENSURE ECONOMIC GROWTH IN THE CURRENT GLOBAL LANDSCAPE.
the automatic route, with government approvals necessary for anything up to 100 per cent. In the absence of this restriction, the speed and scale with which foreign players can roll out their Indian retail operations is expected to see a massive uptick. Along with this, the ability to earn complete autonomy in revenue and strategy over their Indian businesses will also incentivise foreign companies to more fully expand their operations. However, one of the key controls still being enforced in single brand retail is the requirement of 30 per cent (by value) sourcing of business purchases from Indian businesses. Companies can also set off any domestic sourcing for their global businesses against the same quota from India. In this manner, the government hopes to ensure that mid and small size companies in India are not completely left out in the cold.
FDI AND APPAREL RETAIL
According to a report from the Boston Consulting Group, India is on its way to becoming the third largest consumer economy in the world, while an ASSOCHAM study estimates the retail market to be over USD 1.1 trillion by 2020, making it a coveted market for international players. Apparel and fashion are expected to grow as well, from USD 46 billion in 2017 to USD 115 billion by 2026 at a Compound Annual Growth Rate (CAGR) of about 9.7 per cent. Given the potential revenue floating in the Indian market, there is no denying that this move by the government is joyous to foreign investors. With the unimpeded access to 1.3 billion consumers in India’s retail market, wholly owned international brands no longer need to share their returns with local partners.
However, from the Indian perspective, there has been a steady interest in the Indian market by apparel companies for the last 10-15 years. With major American and European brands constantly making headway into the Indian market irrespective of regulations and impediments, the apparel segment isn’t expected to be significantly altered. In fact, more than 19 per cent of the total apparel market in India is now a part of modern retail systems, while other segments like food and groceries only have a three per cent penetration rate. The relative maturity in retail for apparel implies that large global brands and retailers are already well on their way to India while other categories like food and furniture are truly the growth avenues for new money.
While it is possible that some single brand apparel companies will sever ties with their Indian partners and take advantage of the 100 per cent FDI benefit, it isn’t certain. After all, given the intricacies and complexities of the Indian retail market, foreign players have always found it useful to have a local partner. With thoroughly vetted and time tested joint venture agreements already in place, the incentive to strike out alone with the 30 per cent sourcing requirement may not be in the interest of most major apparel companies. The turn to independence will mostly be seen in the largest of companies, who have already enacted fully owned subsidiaries in India and will welcome this chance to be more flexible and enforce greater operational control in the front end of their business.
THE WAY FORWARD
The obvious benefits will, of course, be to small and medium sized sourcing partners as they will find more opportunities to supply these
foreign companies. Given the shorter lead times, lower costs, and ease of access, single brand companies will be hard pressed to build their value chain from scratch. However, we have already seen resistance to this initiative from various groups and associations in the country already, such as Confederation of All India Traders (CAIT) who have already condemned this move by the government. The major concern by CAIT is regarding the impact this will have on smaller businesses which will be unable to compete with major international brands.
This is a realistic concern as we have already seen the impact of such shifts in other countries where multinational companies have driven out local players. However, for the apparel business this may prove to be a problem if many small traders are forced to compete over a large company’s sourcing needs. This will not only risk driving down their profitability but also lead to significant layoffs. Under such an outcome, only large conglomerates within India will be able to survive. However, it is too early to judge whether this is a guaranteed outcome as in the last three months we haven’t witnessed any serious shifts or proposals emerging from global apparel players. The more likely outcome will simply be a great expansion of existing brands and the entry of new ones–as they target tier II and tier III markets to grow their presence. It is only when we start seeing major manufacturing plans from these international companies will we truly see the final impact this policy will have on the Indian apparel market.
THE OBVIOUS BENEFITS WILL, OF COURSE, BE TO SMALL AND MEDIUM SIZED SOURCING PARTNERS AS THEY WILL FIND MORE OPPORTUNITIES TO SUPPLY THESE FOREIGN COMPANIES.