India: FDI changes, IKEA doesn't give up

India and IKEA

Following the period of economic growth seen so far, India now finds itself at a standstill. The growth rate recorded last March stood at around 5.31% YoY compared to the expected 6.11% YoY (the lowest in the last nine years), and although this performance is clearly positive compared to that of the other BRICS countries (Brazil 0.21% YoY, Russia 1.91% YoY, China 1.81% YoY, South Africa 2.71% QoQ) and is in line with the global average (6.75% QoQ), overall the Indian economy has slowed in recent months.

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

In the eye of the storm lately, Foreign Direct Investments in the retail sector have found themselves, especially following IKEA's request to reduce the 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 over 1.5 billion Euros.

The Retail Sector, the Beating Heart of the Indian Economy

With an estimated value of approximately 330 billion euros and an expected growth rate of 12%, India’s retail sector is undoubtedly one of the most dynamic in the entire Indian economy. After the agricultural sector, the retail sector employs over 40 million Indians, or about 3.3% of the total population.

The retail sector in India is characterized by a dichotomy between organized retail and unorganized retail:

• The first refers to commercial activities carried out by authorized retailers registered with government registries who pay taxes owed to the state. This category includes publicly traded supermarkets, hypermarkets, retail chains, as well as large private companies, of course.;
• Instead, the traditional low-cost retail outlets that line Indian city streets belong to the unorganized retail world. These stores are typically family-run and specialize in selling groceries as well as artisanal products and services.

The trend emerging in the sector is the rise of organized retail (which was virtually unknown in rural communities and small villages in India until 2010), which is growing at a compound annual growth rate of 22%. Listed below are the main factors that have driven and continue to drive the sector’s growth:

• the Real Estate boom;
• Higher spending power among young people;
• the increase in the average salary;
• a major shift in consumer needs and increased brand awareness;
• New payment methods that simplify purchases.

Among the various categories into which the retail sector can be divided, the furniture segment accounts for 31% of the total and offers promising growth prospects in a market dominated exclusively by small retailers with a limited product range, who are therefore unable to fully meet the needs of their new customers—who are seeking stylish designs at affordable prices.

Current regulation in the retail sector

For at least 10 years, the topic of FDI in the retail sector in India has been subject to various controversies. Over the years, numerous measures have been adopted to enable the country to define an adequate policy capable of attracting foreign investment from developed countries, which were previously hesitant to enter the Indian market.

In 1997, the Indian government approved a 100% foreign direct investment (FDI) limit in the wholesale sector for the first time. It took about ten years to achieve results in the retail sector: in fact, in 2006, the Council of Ministers approved a 51% ownership limit for foreign companies in the single-brand retail sector. It was not until November 2011 that the proposal allowing 100% foreign direct investment (FDI) in single-brand stores and 51% FDI in multi-brand retail was approved. However, this reform sparked fierce opposition from the governments of several states, and the government first backtracked and then reintroduced the rule granting foreign companies the possibility of obtaining up to 100% ownership of single-brand retail outlets.

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 surprising that the passage of the legislation on FDI in the retail sector was welcomed by organized international retailers. However, it must be noted that current regulations require foreign companies intending to expand into India to source 30% of their revenue from local suppliers within one year of entering the market. This requirement does not satisfy foreign companies for two main reasons:

• The first concerns the fact that we need to consider the costs incurred for the production and transport of products as the basis for calculation, rather than revenue.;
• The second, however, relates to the fact that guaranteeing such a percentage immediately would have several negative effects.

In addition to this, the presence of multiple clauses imposed by the Indian Government is noted. Among these is the requirement to obtain production factors from Indian Small and Medium-sized Enterprises (SMEs) that do not exceed a capitalization of 830,000 Euros in fixed assets. The risk of diluting product quality or failing to achieve a production level that allows for significant economies of scale and specialization, on the other hand, is evident.

It is clear that there are several reasons discouraging 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 no longer consider India a market of strong interest.

However, from the moment IKEA expressed its desire to establish itself in India, expectations placed on the government became enormous: the hope is that New Delhi will consider the possibility of facilitating FDI policies.

IKEA's intentions and demands.

IKEA, the world's largest home furnishing retailer, following the unprecedented success it has found in China and Russia, is indeed considering establishing itself in the Indian market.

The first attempts at a possible entry date back to 2009, which were soon shelved after encountering some problems related to Indian regulations. Despite this, in June 2012, following a meeting in St. Petersburg between the Indian Minister of Industry and Commerce, Anand Sharma, and IKEA's CEO and President, Mikael Ohlsson, the company once again expressed its desire to enter the Indian market. The Swedish giant's intention is to invest €1.5 billion and open approximately 25 new stores in India in the long term.

However, the road ahead is still long and arduous: on June 22, IKEA submitted a request to the Department of Industrial Policy and Promotion asking for a relaxation of the restrictions under current regulations governing FDI in single-brand retail stores. According to a statement released by the company, it appears that IKEA is not currently willing to source 30% of its revenue from Indian SMEs and has therefore requested that the competent authority extend the timeframe by approximately 10 years from the date of approval of the application to meet the required criteria.

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

The DIPP’s response to IKEA’s requests was categorical. Any possibility of extending the period allowed to meet the outsourcing requirements of 30% to 10 years has essentially been taken off the table. In fact, the DIPP does not appear willing to grant the development of ad hoc regulations for IKEA, and for this reason, the business models of 59 other single-brand retail outlets are now being analyzed in search of possible analogies that could also be implemented for IKEA. The Minister for Micro, Small, and Medium Enterprises, Vilasrao Deshmukh, has been categorical on this point, while Prime Minister Manmohan Singh has declared his commitment to ensuring that foreign companies are given a reasonable period of time to comply with the regulations, in an effort to make India a more “business-friendly” country. Among the most proactive ministers, Anand Sharma, Minister of Commerce and Industry, stands out in particular, as he intends to promote more open legislation regarding FDI.

An exciting period of anticipation has begun, which could lead to a possible change in current regulations. The latest rumors suggest the approval of the following changes:

• the application of the procurement requirement for 30 % calculated based on production and transportation costs rather than on revenue;
• the fulfillment of government-imposed requirements within 3 or 5 years of authorization for entry into the Indian market;
• the possibility of continuing to procure from SMEs that exceed the maximum limit of USD 1 million in fixed assets;
• The removal of the rider requiring companies to be direct owners of the trademark.

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

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