India: FDI changes, IKEA doesn't give up

India and IKEA

After the positive period of economic growth that has occurred so far, India is at an impasse. The growth rate recorded last March settled at around 5.3% compared to the expected growth rate of 6.1%, (the lowest in nine years) and although this performance is markedly positive compared to that of the other BRICS (Brazil 0.2%, Russia 1.9%, China 1.8%, South Africa 2.7%) and is in line with the average of the other countries at world levels (6.75%), overall the Indian economy has slowed down in the last period.

One possible way out of this situation could be to promote ad hoc policies that encourage investment in the country by both local and foreign companies.

In the eye of the storm lately has been Foreign Direct Investment in the retail sector, especially in the wake of IKEA's request to ease restrictions imposed by the Indian government on FDI in single-brand retail. The Swedish giant has expressed its interest in the local market and its intention to invest more than 1.5 billion euros.

Retail sector, beating heart of India's economy

With an estimated value of about 330 billion and an expected growth rate of 12%, the Retail sector in India is certainly among the most active in the entire Indian economy. After the agriculture sector, the Retail sector provides employment for more than 40 million Indians, or about 3.3% of the entire population.

The retail world in India is characterized by a dichotomy between Organized Retail and Unorganized Retail:

• with the former denotes those commercial activities conducted by licensed retailers who are registered with the government records and who pay taxes due to the state. This category includes listed supermarkets, hypermarkets, retail chains as well as large private companies, of course;
• In contrast, the traditional low-cost retail outlets that enliven the streets of Indian cities belong to the world of unorganized retail. Such stores tend to be family-owned and specialize in selling groceries as well as handicraft products and services.

The trend emerging in the sector is really about the emergence of organized retail (until 2010 unknown in rural communities and small villages in India), which has a weighted annual growth rate of 22%. The main factors that have driven and continue to drive the sector's growth are listed below:

• the Real Estate boom;
• A higher spending capacity on the part of young people;
• The increase in average salary;
• a major shift in consumer needs and increased brand awareness;
• The new payment methods that simplify purchases.

Among the various categories into which Retail can be divided, the furniture segment constitutes 3% of the total and has interesting prospects for expansion in a market characterized exclusively by small retailers with a limited product range and therefore not fully able to meet the needs of its new consumers, who are looking for a design style but at affordable prices.

Current regulation in the retail sector

For at least 10 years, the issue of FDI in India's retail sector has presented several controversies. There are many steps that have been taken over the years to enable the country to establish an appropriate policy capable of attracting foreign investment from developed countries that were previously reluctant to enter the Indian market.

In 1997, the Indian government first approved the 100% of FDI in wholesale. It took about a decade to achieve results in the retail segment: in fact, in 2006 the Cabinet approved the 51% ownership quota for foreign companies in single-brand retail. Only in November 2011 was the proposal approved that would have allowed 100% of single-brand stores and 51% of FDIs in multi-brand retail. However, this reform triggered fierce opposition from the governments of several states, and the government first backtracked and then reintroduced the rule giving foreign companies the ability to obtain up to 100% of ownership shares in single-brand stores.

These measures have come at a time when retailers worldwide are facing critical issues in their home countries and are therefore looking for new emerging markets where they can find easier conditions for their business.

It is therefore not strange that the passage of FDI legislation in the retail sector was welcomed by international organized retailers. However, it cannot be overlooked that the current regulations require foreign firms intending to expand in India to partially source from local suppliers in an amount equal to 30% of their revenues within one year of market entry. This measure does not satisfy foreign companies mainly for two reasons:

• the first relates to the fact that costs incurred in the production and transportation of products, rather than revenues, should be considered as the basis for calculation;
• the second, however, relates to the fact that guaranteeing such a percentage in the immediate term would have several negative effects.

In addition to this, there are multiple clauses imposed by the Indian government. These include the need to obtain inputs from Indian Small and Medium Enterprises (SMEs) that do not exceed a capitalization of 830,000 euros in fixed investments. On the other hand, the risk of diluting product quality or failing to achieve a level of production that would allow for strong economies of scale and specialization is clear.

It seems clear that there are several reasons that discourage foreign companies from investing in Retail in India: for these and other reasons, some companies have decided to postpone their entry into the Indian market or even to stop considering India as a market of strong interest.

However, since IKEA expressed its desire to set up in India, the expectations placed on the government have become enormous: the hope is that New Delhi will consider facilitating policies regarding FDI.

IKEA's intentions and demands.

In fact, IKEA, the world's largest home furnishings retailer, following its unprecedented success in China and Russia, is considering establishing itself in the Indian market.

The first attempts at a possible entry date back to 2009, soon shelved after some problems encountered in relation to Indian regulations. Nevertheless, in June 2012, following a meeting in St. Petersburg between India's Minister of Industry and Trade Anand Sharma and CEO and IKEA Chairman Mikael Ohlsson, the company again expressed its desire to enter the Indian market. The Swedish giant's intention is to invest an amount of 1.5 billion euros, opening about 25 new stores on Indian soil in the long run.

The road ahead, however, is still long and troubled: on June 22, IKEA sent a request to the Department of Industrial Policy and Promotion for a relaxation of restrictions on the rules in place for FDI in single-brand outlets. From a statement issued by the company, it appears that IKEA is unwilling in the immediate term to source 30% of its revenues from Indian SMEs and therefore has requested an extension of the time horizon of about 10 years from the date of approval of the application from the competent authority to meet the requirements.

Responses from the Indian government and possible changes in the near future

DIPP's response to IKEA's request was peremptory. Any possibility of extending the period allowed for meeting the outsourcing requirements of 30% to 10 years has essentially been removed from the negotiating table. The DIPP, in fact, does not seem to be willing to grant the development of ad hoc legislation for IKEA, and for this reason the business models of 59 other single-brand stores are now being analyzed, looking for possible similarities that can be implemented for IKEA as well. Minister for Micro, Small and Medium Enterprises Vilasrao Deshmukh has been adamant in this regard, while Prime Minister Manmohan Singh has stated his commitment to giving foreign companies a reasonable amount of time to comply with the regulations in an effort to make India a more “business friendly” country. Most notable among the more diligent ministers is Anand Sharma, Minister for Trade and Industry, who intends to promote more open FDI legislation.

Thus, a period of electrifying anticipation has begun that could lead to a possible change in the current legislation. The latest rumors would point to the approval of the following changes:

• The application of the procurement requirement for 30 % calculated on the basis of production and transportation costs instead of revenues;
• fulfillment of government-imposed requirements within 3 to 5 years of allowing entry into the Indian market;
• The ability to continue sourcing from SMEs exceeding the maximum limit of US$1 million in fixed investment;
• The removal of the rider requiring companies to be direct owners of the trademark.

There are many interests at stake in the affair, and strong opposition has been exerted by the Minister for Micro, Small and Medium Enterprises himself, who is trying to protect the interest of the latter, who fear being excluded from the market and becoming victims of excessive bargaining power wielded by foreign companies. The situation is likely to evolve in the coming weeks.

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