Just FDI in retail isn't enough: 2nd June 2011 Financial Express

There is talk once again of allowing FDI into retail. This thought has been driven not so much by change in ideology of being less xenophobic but by the high food inflation numbers. The fear is quite palpable that inflation may not come down that easily and that FDI can provide some comfort. Let us see how this can work.

FDI in retail as typified by Wal-Mart or Carrefour are examples of how quality products are delivered to the customer at low prices. These companies provide end-to-end solutions to deliver superior results with the creation of logistical support being an integral part of their business models. They procure foodstuff cheap and have it delivered via their retail outlets through modern storage, processing and transportation, thus eschewing wastages. All this is done maintaining standardisation in quality, which adds value for the customer.

This looks like the cure that we are looking for, as the government has admitted that the extent of losses in horticulture could be around 40% due to absence of cold storage chains. The Budget provides incentives here and there, but definitely cannot create such superstructures. This is where FDI matters. Today, FDI is permitted in cold chains, but no one is interested as retail, which is the creamy layer, is out of its purview. Once allowed, their business models would bridge the gap. A study carried out by NABARD some years ago showed that the farmer gets just around 30% of the final price paid by the consumer in certain horticulture products. The World Bank puts this at around 15%. FDI will help to truncate this value chain and ensure that both sides get a better deal as it rakes in its profit. This way it is a win-win situation.

If the solution is quite simple then what is holding us back? Essentially the retail segment in India is in the unorganised sector with just about 3-4% qualifying as organised. A large number of small mom-and-pop stores exist that serve as points of sale with many being brought into the fold of some of the Indian corporates. A sudden influx of FDI would threaten these small outlets as well as the corporates that have built this retail franchise in the smaller towns.

Today consumers are driven by prices and quality. If both are offered, which will be the case with FDI, then the natural choice would be to switch loyalties. This is already evident in the metro cities where organised retail has made significant inroads, with the positioning in a mall working well for the owners as well as for the consumers from all income streams. Given that around 33 million are employed in this segment, will there be any adverse consequences? The kiranas will still have their place, given the smaller quantities that they deal with, provision of home delivery, credit etc.

Further, the solution would be to integrate these outlets in the model where they become franchisees of the superstore for a commission just as being done by chocolate, soft drinks and cosmetic firms. In fact, the fresh employment opportunities that will be generated would be significant with superior skill sets being imparted. The icing will be provided to the government in the form of better tax collection as organised retail has a tax audit trail.

The class to be affected severely would be the intermediaries who would lose their grip on the market. The barrier here will be erected in the form of political interference as there will be parties that are sympathetic to this class who will oppose this move as it will virtually keep them out of business once the model develops.

There is a concern of the FDI entrants squeezing the farmers, which has been the case in the West. This is something that the government has to address with its price support policies that are otherwise relevant for only rice and wheat in out context. This will minimise this threat of farmers being squeezed.

There are, however, two reforms that have to be implemented as precursors to getting in FDI into food retail. The first is that the APMC laws have to be amended to allow for free movement of farm products across states. In the absence of the 2003 Model Acts being passed, it will not make sense for any investor to enter this area. Currently, there are restrictions on the movement of goods across states and, as a result, products grown in a state can be sold only in the same region, which, in turn, imparts rigidity to prices given that the mandis are oligopolistic in nature. The other is to formally permit and encourage the concept of contract farming as this will benefit the farmers directly once the FDI investors are in. In fact, these two reforms will provide the current domestic organised retail this advantage that can minimise the distance between the foreign counterparts when they are permitted.

But, will this help to reduce food inflation? The answer is still a shoulder shrug because there are certain factors at play that have severed the relation between higher production and lower prices. The first is the price policy of the government. MSPs tend to increase the benchmark prices in the market even when there is no direct procurement. The second is that as farm productivity has been stagnant or increasing only marginally, farmers will increase their prices to maintain their consumption levels at higher inflation levels.

FDI, as a rule, is good for the country and in the case of retail (food) will definitely bring in value by filling lacunae that we have not been able to address in the last 60 years. By truncating the value chain and cutting down wastages, it can, along with ‘domestic organised retail’, change the landscape of retailing of food products. The farmers will gain, consumers will be better off, kiranas will survive or get integrated in the model while the nation benefits from the investments. The intermediaries will probably have a hard time, but then they were anyway not really adding value. Therefore, this should be welcomed and introduced with some urgency when sentiment is also at a high. But, this may not yet be a panacea for our price woes.