FDI in retail: 101
Let me tell you a real life incident that I encountered just a month ago. It was 2-3 days before Diwali and after a hectic day at work I was leaving for home. I noticed a police check-post and was asked to stop. I obliged and got down from my vehicle. I was asked for license. When I inquired about the reason, I was told that I had jumped a red-light (which I had not). I tried to explain the policeman, but he refused to listen. Now how do I prove that I haven’t jumped the red-light.
This was the first time I saw this particular check-post. Furthermore, there were no such check-posts in the rest city, only in the area where there corporate offices. It was obvious, the man wanted a bribe, Diwali was round the corner. He knew that I would have run around to get my license back, particularly so close to Diwali.
Does this sound familiar to you? Have you ever faced such harassment? This is what actually happens on the ground.
How is this related to Retail?
Let me tell you two stories. The names used are fictional but I have heard such stories.
Story 1: Guptaji is small retailer and the following conversation took place when a Weights and Measures inspector visited his shop.
Guptaji: “Welcome sir”
Inspector: Picks up a branded 5 kg rice packet and measures it. The reading says 4.99. “This is 10 grams short”
Guptaji: “Sir this is company’s product, it’s branded”
Inspector: “Whose shop is this?”
Inspector: Goes ahead and weighs a few more items. He is able to find one more mismatch, this time it is a 10kg packet of atta. “Now this is also short. Guptaji what is all this”, this time in much more threatening tone. He now goes ahead starts to weigh more items.
Guptaji: He gets the hint, tells his servant to put some items (rice, atta, etc) into Inspector’s car. “Sir, how much will you measure, lets close the matter here.”
Inspector: “Hmm, take care from next. Measure each an every item before you buy from your supplier”
Story 2: Sharmaji, another small retailer and the following conversation took place when a Sampling inspector visited his shop.
Sharmaji: “Welcome sir”
Inspector: Pulls out a packet of branded ghee for testing. Opens the packet and tests it. “This has failed the test. ABC parameter should be less than 10.2 but the reading says 10.3. What have you been mixing?”
Sharmaji: He is little confused. He doesn’t understands what ABC parameter means, he is not that well educated. “But this is a branded product. Sir, you yourself opened the packet”
Rest of the story follows a familiar pattern.
Is there a Level playing field
This is what actually happens on the ground. These are just few small examples of the kind of issues that are faced daily by millions of small retailers across India. Big retailers are unlikely to face such issues because of their size and clout.
Regulations in India are outdated. They are particularly severe when it comes to food items. Such outdated regulations breed and promote corruption. They inhibit growth of small businesses which are often much more labor intensive.
Small businesses also find it difficult to raise money in the form of loan. As professor Vaidyanathanpoints out, small businesses get credit from 30% to upto 180%. Compare that to Walmart which can raise money at just 4% from foreign banks.
Is this a level playing field? This is a David and Goliath fight. What’s worse is that the small retailer is being asked to fight with both his hands tied behind his back.
Will FDI really cool Inflation and help farmers
The following are the main arguments that are frequently put forward in favor of FDI in retail.
- FDI will remove middle-men and increase farmer incom
- FDI will reduce inflation
Now let me systematically destroy these myths.
Myth: Greedy bania is cheating farmers
There are three kirana stores in my market which cater to the people living in our sector. They compete among themselves. Each one offers free home delivery of goods and tries to offer best services and prices. The notion that these retailers are cheating customers is absurd. Yes, the supply chain is inefficient, but it’s not retailer who is disproportionately marking up the costs. No retailer can overcharge because of intense competition.
Myth: Farmer Incomes
FDI in cash and carry trade is already allowed and Walmart is already in India. Walmart in partnership with Bharti Enterprises has already launched Best Price – a modern wholesale cash and carry store. In these stores, ordinary customers are not allowed. Only whole sellers and retail shop owners are allowed.
The first such store opened in 2009, nearly three year ago. Let us assume that a retailer purchases from Best Price, marks up costs by 20% (retailers margin).
Now the only additional costs that FDI will reduce will be around 20%. So if the inflation is 10%, FDI can bring it down to only 8%, not more.
FDI in retail is now being sold as magic pill for solving inflation. Not so long ago, we were told that NREGA would solve rural problems. Recently we were told that rate hikes by RBI will reduce inflation. Inflation is systemic issue and not at supply side. Supply side not same as supply chain.
- Inflation is because of supply side constraints. We need higher agriculture production.
- Agriculture production has barely grown at 2-3% in the last 20 years.
- Mere efficient supply chains will not itself increase production.
- Large number of farmers are quitting agriculture because they are finding it unviable
- NREGA has pushed up cost of agriculture labor thus pushing up input costs
- APMC Act prohibits direct sourcing by big retailer from farmers, how is FDI going to change that.
An article in MoneyLife rightly points out that significant cost reduction can be achieved by simply by amending APMC act and implementing GST to facilitate cross border.
Agriculture reforms are required
Unless the production of food items is increased, nothing much will change on the inflation front. FDI might bring temporary relief, but it will not be a sustainable one. What is need is lasting reforms in agriculture:
- Better irrigation: Sustainable agriculture, small check dams, water conservation are needed
- Better rural connectivity: Pradhan Mantri Gram Sadak Yojna started by NDA Govt under Vajapayee has been pushed to the back burner.
- Agricultural Universities need to established
- Modern agricultural practices like drip irrigation need to be introduced and farmers need to educated.
What about Free Markets
Free markets means FDI in retail should be allowed, this is a myth that everyone seems to be propagating. It is time to sit back understand what free markets mean and what the dangers are. In such times, it is important to listen to the other side, to listen to the harshest critics of capitalism – Karl Marx.
Karl Marx was someone who over-criticized capitalism and oversold socialism. Socialism rejects the idea of efficient markets. The very idea that a group of bureaucrats in planning commission could plan everything that an economy needs is regressive.
Socialism assumes a static world. The world is in fact dynamic and there is constant innovation, something that cannot be planned. There are no incentives for initiatives and innovation. This is a basic design defect in socialism.
Thus socialism was designed to fail. The erstwhile USSR’s accomplishments were only in areas that the government decided would be important which happened to missiles and nuclear bombs. The standard of living of ordinary people was far lower as compared to the West.
Capitalism’s design issue
Capitalism has profit motive and thus it provides necessary motivation and incentive for innovation. At the same time, in its quest for profit maximization, capitalism can also drive companies into unfair monopolistic practices. Walmart for e.g. has been accused of predatory pricing tactics world over.
Free markets does not mean “No controls at all”. It must also include appropriate regulatory mechanism to ensure fair competition. Given the state of our institutions, we must ask ourselves, “Do we have the necessary capability to have a regulatory authority that can function in an unbiased way”.
Adam Smith, the father of free market economics said, “In the long run, markets are able to find equilibrium”. Keynes countered that with, “In the long run we all are dead”.
The question is how long it will take to reach that equilibrium. What about the pain that we are going to witness until we reach that equilibrium. You can imagine the scale of pain when there are 40 million people or about 8% of workforce in this sector.
What about domestic retailers
Karl Marx said, “Capitalism will destroy itself. You can continue to replace labor with capital”.
In its quest for cost reduction, capitalism has a tendency to continue to replace labour with automation. It is important to slow down this tendency of capitalism. This change in policy is going to bring in new winners and losers. Large number of jobs that are promised to be created will be blue collar jobs and will be taken up by those who are well educated. The jobs that are going to be destroyed will be that of semi-literate.
It is true that the domestic retailers are also operating in India and the kirana shops have survived the onslaught. The annual rate of closure of retail shops is less than 2%. This statistic does not take into account the fall in margins and volumes of the domestic retailers. Introduction of FDI in retail is going accelerate this process.
While change is the only constant, it does not means that we should bring in big bang changes at once. It is unreasonable to expect a 50 year old person to look for another job.
Why is our retail sector so fragmented?
No matter on which side of the FDI debate you belong to, don’t EVER EVER EVER forget why our retail sector is so fragmented. The sole responsibility of this goes to the Congress party and Indira Gandhi.
India was a closed economy which was further closed by Indira Gandhi when she nationalized banks. By nationalizing banks it became almost impossible for anyone raise money without paying a bribe or having political connections. This meant there was limited scope for an emergence of a big player in the retail sector.
With the economy growing at a Hindu rate of growth, it meant very few job opportunities. It was under these trying circumstances, several million Indian became self employed. Now this sudden reversal of policy by Congress will destroy a large number of them.
Why FDI in retail is different
It is simply its huge size. 8% of the workforce i.e. 40 million people are employed in this sector. Only 4% of Indian retail outlets are more than 500 sq ft. Where will all these people be employed? We need to first bring in other reforms like labor reforms which can create jobs in manufacturing, thus creating less pain.
While FDI in general is good because it brings in the best practices and also more competition, FDI in retail is different from FDI in other sectors.
Take the example of FDI in Banking and Insurance. Insurance penetration is less than 5% people, i.e. less than 5% of the people are insured. Likewise large numbers of people, particularly in rural areas don’t have bank accounts. An FDI in this sector would help in spreading banking and insurance services. Retail is already there and a huge chunk of people are dependent on this.
Or take the case of FDI in Defense. Every year India imports 70% of its defense equipment worth billions of dollars. India does not even have the capacity to produce bullet proof jackets, leave alone high-end aircrafts and warships. Most countries are unwilling to share the latest technologies. Defense imports are also subject to sanctions like those imposed post-Pokhran tests.
Does it not make sense to raise the FDI limit in defense from 26% to 51 or even higher. If we are already importing defense equipments, why not produce them within our borders where no sanctions can be imposed. The reason this is not happening is defense the unions of Defense PSUs are opposing it UPA hasn’t shown the metal to face them.
If a few thousand employees can have a veto power over India’s future defense needs, surely 40 million people count for something. Why take this decision in haste.
Change is the only constant and with time our retail sector will move from unorganized to much more organized state. The problem is managing this change.