FDI in retail: The argument continues - II - Views on News from Equitymaster

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FDI in retail: The argument continues - II

Mar 31, 2011

In our earlier article in this series we have discussed the key logic for allowing foreign investment (FDI) in Indian retail sector. We now take the discussion forward to dwell on the key positives and negatives of the proposal and how are they likely to impact investor returns.

Why FDI?

40% of the food produced in the country gets wasted. This is while a third of the country’s population cannot afford two square meals a day. Agreed, having large shopping malls and MNC retail outlets may not solve this problem. However, investments in the retail supply chain and storage could certainly help in finding a solution for preserving critical food produce. Global retailers have the necessary know how and expertise to build that infrastructure. But the bait that could lure them to markets like India is higher profit sharing and that too in an economy where a billion plus people are looking to consume more. And that is the key underlying rationale for FDI in retail.

In food retailing, better supply chain and technical knowhow would ensure that the transit of produce from farm to shop floors is smooth. With the elimination of middlemen, the prices will also be reduced thereby benefitting the consumer. Contract farming will benefit the farmers. Better prices for their farm produce and timely sale of the perishable goods can help the agriculturists earn more.

For the more established and multi format retailers, FDI will mean ready availability of equity funds without taking the risk of excess leverage. The funds will help in executing their expansion plans and thereby offer better revenue visibility. Also in times of stress, a number of retailers have had to shut shop for want of funds and excess leverage. The foreign partnership can help resolve this issue besides helping to set up a strong back-end infrastructure.

Why not FDI?

Now with everything going in favour of the foreign partnerships, one would wonder what can go wrong. The policymakers concerns arise due to the possible fate of smaller family managed businesses (kirana shops) that may cease to exist. The inability of the smaller players to fetch better prices from large vendors and operate on thin margins could lead to their extinction. Besides unemployment, the ability of the small format stores to reach out to the rural masses may also be compromised upon. Hence the government needs to ensure that the FDI does not bring any undue favour only to the larger players.

It is also argued that the global retailers will initially reduce prices drastically with a view to oust local competition. Once they have successfully established their operations, they would raise back the prices.

What will FDI in retail mean for investors?

For one we do not believe that 100% FDI in retail will come anytime soon. For as long as the economies of scale help the retailers make decent margins the foreign investments can be restricted to limited few. However, a gradual and partial opening of the sector is what the industry players are advocating for. Rightly so! The investments in supply chain and storage will not only help the retailers expand and improve margins but will also help the smaller players fetch better bargains. At the same time this could solve the problem of wastages. What is more, the benefit of lower costs could then be passed on to consumers in the form of reduced prices of goods.

Thus investors can certainly look forward to increased foreign participation in the Indian retail sector. But do look out for players that have the long term interests in mind. That is the ones who are not just setting up more shops but also ensuring that the back end infrastructure is in place, more importantly, ones that are doing so without excessive leverage. We believe the Indian retailers can duplicate the Walmart story only by strengthening their own infrastructure; rather than relying too much on foreign players.

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