»The Honest Truth by Ajit Dayal

FDI in retail has failed
27 DECEMBER 2011

There is a raging debate on FDI in retail but, guess what, it's already here - and it has failed big time.

FDI in financial services retail has been here since 1993 and it has been a disaster for the consumer.

Consider this: in 1992 the only mutual funds available to local Indians were run by the Unit Trust of India and a handful of other PSUs like SBI Mutual Fund and Canbank Mutual Fund. At that time UTI alone owned 10% of the value of all listed Indian shares. This means that local Indian investors, via their ownership of the units of UTI, owned 10% of the Indian stock market.

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Then, in 1993, we allowed FDI in the retail mutual funds business.

Under the FDI rules, if a foreign fund house wanted to own 100% of the mutual fund business in India, it needed to bring in USD 50 millionas equity in the company. If the foreign fund house wanted to own 76% (but less than 100%), it had to bring in USD 25 million as equity. And, if the foreign fund house wanted to own 51% (but less than 76%), it needed to bring in USD 5 million as equity in the mutual fund business.

Foreign mutual funds dominate, retail presence wilts

The policy was a success.

Today, out of the 42 active mutual fund houses managing Rs 712,742 crore worth assets in all their mutual funds (average assets for the quarter ended September 2011), about 56% of the assets are managed by the 19 mutual fund houses classified by AMFI as joint ventures or foreign owned.

So, FDI in the retail fund management business has been a "success". Foreign money and foreign technology have been imported into India. Most of the foreign companies have "successful" and profitable India businesses.

But, has the Indian retail investor benefitted?

My view: the entry of foreign fund houses has been a disaster for the Indian retail fund investor.

How many investors were there in mutual funds pre-1992? UTI alone had 40 million folios.

And how many are there today? Probably 10 million folios.

Furthermore, the Indian mutual funds - after 18 years of reforms in that sector - now own less than 3% of the Indian stock market. (Recall that UTI alone owned 10% of the Indian stock market in 1992.) By owning less of the Indian stock market over the past 18 years, Indian investors have lost out on the opportunity to see the value of their savings increase and participate in the long-term, wealth creation power of the Indian stock market. The BSE 30 Index was hovering around the 500 levels in July 1991, it is hovering around 15,000 today - a 30x increase in 20 years. Not a linear, guaranteed annual increase, but a good return all the same for patient, sensible long term fund managers - and their investors.

But FDI in the mutual fund business did not bring in any ethics or good practices. It did not "deepen" the market. In fact, one could argue - based on the scandals and exposes that continuously hit the global headlines - that foreign financial companiesgrew in their home countries because they resorted to illegal and unfair practices! And these financial giants have enjoyed the support of their home governments in the quest to maximise their profits at the cost of their clients.

In the mutual fund business, rather than fighting for the good of their clients, the foreign firms have sustained and supported an opaque distribution channel. Their objective was "growth at any cost". Even at the cost to their customers.

Does "foreign" equal "fair"?

Of course, you can't blame the failure of Indian retail presence solely on the failure of the FDI-run mutual fund houses to fight to create a better system. There were scandals in the Indian stock market and UTI - with some 40 million folios lying in good faith and trust - mismanaged the funds and dealt a body blow to the Indian psyche with its spectacular collapse in 2002. The best-selling Unit Scheme 1964 of UTI was a "guaranteed" return product investing in wildly swinging stock markets - a classic case of mis-selling.

SEBI - with or without pressures from governments and politicians - allowed many questionable companies to operate as financial intermediaries and even more questionable managements to access the capital markets. With a slow-moving punishment for fraud, investors have seen no justice. A global reality.

But did the mutual fund industry - dominated by the more experienced foreign-controlled partnerships or fully-owned enterprises - do anything with its power as a large owner of Indian shares? Did the fund managers with these FDI-compliant ventures make statements on lack of integrity in specific managements? Did fund managers bother to cast their votes - however small - at AGM's in a manner that would send a signal of good or bad corporate governance? And, if they did, to what extent did they do so? Could it have been better?

And the "success" of FDI in insurance is a question mark. Many of the same players in the mutual fund business also have the licenses to sell insurance policies. Well, guess what? Many resorted to the distribution-led opaque practices there, too. ULIPs were mis-sold and it took the then SEBI Chairman, Mr. Bhave, to fight this out with the IRDA last year and get the attention of the Finance Minister. Mr. Bhave was refused his extension partially for this high-profile fight. In an LIC and GIC world, you dealt with boring product and slow service. In an FDI-ruled insurance world, you are dealing with better service - but questionable practices and products. Choose your poison.

FDI in banks is also been in existence for a long time. The foreign banks are here and are owned by their global parents. On the banking side, they have not done as well as their domestic competitors but on the "selling product" side they match the local banks stride for stride. The Private Client Divisions of these large global banks have also been party to the mutual fund and ULIP distribution excesses.

The discussion over FDI in retail is being sold as a magic wand that will solve all of India's problems. The pitch is that FDI-compliant companies like Wal-Mart will come in, is the argument, and they will ensure that there is better infrastructure, better supply-side channels, and direct dealings with farmers. This will then ensure a stable and lower pricing regime for all of us end-consumers.

"Foreign is fair", is the unsaid claim.

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Who will they partner with?

What if Wal-Mart partners the very politicians who control the supply side chain? It is an open secret that politicians or their well-connected friends can hoard at will and distort near term price movements.

The thought of a Wal-Mart tying up with farmers directly is being sold to us as a way to make the whole "FDI in retail" a win-win in our heads. But the big-box retail will probably tie up with those very groups who can make life in India easier. And that will lead them to the big and the mighty.

Those that can oil the system.(Hence, a Wal-Mart / Ajit Dayal partnership is not a likely scenario!J)

In November 2010 the price of onions surged to Rs 80 per kg. Yes, there was a bad crop but did that justify a 6x increase in prices? Government intervention brought the price down in the near term - governments tend to shed tears over onions because they have lost elections over them! Now, the price of onions has dropped to Rs 5 per kg because of a better crop and the government is setting a minimum price to save the onion growers!

Would FDI alone cure this problem or would better supply chain systems (even if Indian owned) solve this problem?

Or would a home-grown Amul, the architects of the milky white revolution, solve the problem?

Or is this wild movement in onions representative of the very nature of farm output? That it is unpredictable, that prices can swing wildly, and that farmers will react to price signals as they choose their next crop? So, when the price of onions or wheat surges; the farmers devote more acreage to the crop; there is better supply next season; the price drops.

Can FDI in the front-end store change this cyclical nature of prices and production? Would a big box foreign-owned retail firm with a nice ambience and some clean shopping aisles solve this problem?

Well, I don't know what FDI in retail will do. But did the foreign-owned mutual fund houses clean up the opaque distributions systems?

No, they partnered with them and made it worse!
The point is not that all foreign-owned entities are bad and crooked. Sure there are some good folks out there in every business - even in the wicked and evil world of financial services!

The point is that foreign-ownership by itself is no guarantee of better and transparent systems. FDI in retail is being sold as a "cure". This is a lazy policy that hopes that the foreigner will come in and improve India.

The real investment and policy-making has to be in supply chains - whether owned by locals or by foreigners.

The real discussion has to be in breaking the monopolies and barriers that presently allow fewer goods to perish at the farm and more quality food to reach our plates - at lower prices.

FDI in mutual funds has not achieved that.

FDI in insurance sounds like it went down the wrong path.

FDI in retail could also fail to deliver. Foreign may not be fair.