India: changes to IDEs, IKEA does not give up

India and IKEA

After the successful period of economic growth so far, India is at an impasse. The growth rate recorded last March settled at around 5.3% compared to the expected rate of 6.1%, (the lowest in the last nine years) and although this performance is clearly 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 other countries worldwide (6.75%), overall the Indian economy has slowed down in the last period.

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.

Foreign direct investment in the retail sector has found itself in the eye of the storm in the last period, above all following IKEA's request to reduce the restrictions imposed by the Indian government on FDI in mono-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%, the retail sector in India is certainly among the busiest in the entire Indian economy. After the agricultural sector, the retail sector offers work to over 40 million Indians, or about 3.3% of the entire population.

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

• the first indicates those commercial activities carried out by authorized resellers registered in the Government registers and which pay the taxes due to the State. This category includes listed supermarkets, hypermarkets, retail chains and of course large private companies;
• on the other hand, the traditional low-cost retail outlets that enliven the streets of Indian cities belong to the world of unorganized retail. These shops tend to be family-run and specialized in the sale of foodstuffs as well as handcrafted products and services.

The trend that is emerging in the sector concerns precisely the emergence of organized retail sales (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 growth of the sector are listed below:

• the real estate boom;
• a higher spending capacity on the part of young people;
• the increase in the average salary;
• a strong change in consumer needs and greater 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 presents interesting prospects for expansion in a market characterized exclusively by small retailers with a limited range of products and therefore not completely able to satisfy the needs of its new consumers, looking for a design style but at reasonable prices.

Current regulation in the retail sector

For at least 10 years, the issue of FDI in the retail sector in India has been controversial. There are many measures that have been adopted over the years to allow the country to define an adequate policy capable of attracting foreign investments from developed countries, previously reluctant to enter the Indian market.

In 1997, the Government of India first approved the 100% of FDI in wholesale. It took about ten years to obtain results in the retail segment: in fact, in 2006 the Council of Ministers approved the share ownership of the 51% for foreign companies in the mono-brand retail world. 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 has triggered the very tough opposition of the Governments of various States, and the Government first backtracked and then reintroduced the rule which gives foreign companies the possibility of obtaining up to 100% of the shares of ownership of mono- brand.

These measures have come at a time when global retailers 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 FDI regulation in the retail sector has been welcomed by international organized retailers. However, it cannot be ignored that the current legislation provides that foreign companies intending to expand in India must partially obtain supplies from local suppliers equal to the 30% of their revenues within a year of entering the market. This measure does not satisfy foreign companies mainly for two reasons:

• the first concerns the fact that the costs incurred for the production and transport of the products must be considered as the basis for the calculation, rather than the revenues;
• the second, however, is related to the fact that guaranteeing such a percentage in the immediate term would have various negative effects.

In addition to this, there are multiple clauses imposed by the Government of India. 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 the quality of the product or of failing to reach a level of production capable of allowing strong economies of scale and specialisation, is evident.

It seems clear that there are several reasons which 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 no longer consider India as a market of strong interest.

However, since IKEA has expressed its desire to establish itself in India, the expectations placed on the Government have become enormous: the hope is that New Delhi will consider the hypothesis of facilitating policies regarding FDI.

IKEA's intentions and demands

IKEA, the world's largest retailer of home furnishings, following the unprecedented success in China and Russia, is in fact evaluating the possibility of 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 the Indian regulation. Despite this, in June 2012, following the meeting in St. Petersburg between the Indian Minister of Industry and Trade Anand Sharma and the CEO and president of IKEA, Mikael Ohlsson, the company again expressed its desire to enter the Indian market. The intention of the Swedish giant is to invest an amount equal to 1.5 billion Euros, opening about 25 new stores on Indian soil in the long term.

However, the road ahead is still long and troubled: on 22 June, IKEA sent the Department of Industrial Policy and Promotion a request for a reduction in the restrictions relating to the regulations in force for FDI in single-brand stores. From a press release released by the company, it seems that IKEA is not immediately willing to obtain supplies from Indian SMEs for an amount equal to 30% of its revenues and therefore has requested the competent authority to extend the time horizon by about 10 years from date of approval of the application to meet the required requirements.

The answers from the Government of India and possible changes in the near future

DIPP's response to IKEA's requests was peremptory. Any possibility of extending the period granted to meet 30% outsourcing requirements to 10 years has essentially been removed from the negotiating table. The DIPP, in fact, does not seem to be willing to allow the development of ad hoc legislation for IKEA and for this reason the business models of another 59 single-sign stores are now being analysed, in search of possible analogies that can also be implemented for IKEA . Minister for Micro, Small and Medium Enterprises Vilasrao Deshmukh has been adamant in this regard, while Prime Minister Manmohan Singh has declared his commitment to guaranteeing foreign companies a reasonable period of time to comply with the legislation, in an attempt to make the India a more “business friendly” country. Among the more diligent Ministers, Anand Sharma, Minister for Trade and Industry, stands out above all, who intends to promote more open legislation on the subject of FDI.

A period of electrifying anticipation has therefore begun which could lead to a possible modification of the current legislation. The latest rumors would suggest the approval of the following changes:

• the application of the procurement requirement for 30 % calculated on the basis of production and transport costs instead of revenues;
• the fulfillment of the requirements imposed by the government within 3 to 5 years after the authorization to enter the Indian market;
• the ability to continue sourcing from PMIs exceeding the USD 1 million ceiling in fixed capital formation;
• the removal of the additional clause which requires companies to be direct owners of the trademark.

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

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