By Ramesh Sethuraman, Guest Contributor

For the past three years developments specific to Indian retail’s Foreign Direct Investment (FDI) have been closely followed by retailers across the world. But recently, the United Progressive Alliance (UPA), led by the Indian government, has made relaxations to FDI regulations that are favorable for foreign investors. Unfortunately, this is like watering a cut-down tree hoping it will yield more fruit. Let’s see why.

Current Economic Situation

Due to its economic growth potential, India has long been an under-the-radar destination for several western retailers. However, this country, which has such great economic prospects and is led by a Prime Minister who claims to be an economist, is going through a rough patch, and primarily due to the following reasons:

1. Continuing bad governance, corruption and scams by the United Progressive Alliance (UPA) government;
   
2. Implementing bad economic policies in the name of “reforms “; 
3. A trade deficit of $191.6 billion (US) across 80 countries in 2012-13; 
4. The current account deficit of the central government alone is estimated to be around 4.8% of GDP in the last fiscal year ended 31 March 2013, (4.2% during prior fiscal year);
   
5. Failure to retain or attract new foreign investments while existing investors pull out of the market;
   
6. Inflation remaining near 5%;
   
7. Weak Indian Currency (INR has breached a historic 61.5 mark against the US Dollar;)
   
8. Increase in fuel prices due to currency depreciation;
   
9. Shrinking of the services sector which contributes 60 % to the country’s economy;
   
10. Aggravating the volatility in the market (Over 45% of NSE stocks are currently trading below 2008 lows);
    
11. Industrial stagflation. The manufacturing sector, which constitutes about 76 percent of industrial production, shrank 2.0 percent from a year earlier. Production is continuing to slide while the inflation remains high; and,
    
12. Debt mutual funds fell to Rs 1.29 lakh crore ($21.5 billion USD) in July 2013 end because of large-scale redemption following the recent liquidity-tightening measures taken by the Reserve Bank of India (RBI) to arrest the rupee’s slide.
    

Needless to say, most of the above issues create a domino effect on the others.

The end result is India getting negative ratings from various economic bodies and organizations:

1. Goldman Sachs has recently downgraded the sluggish Indian economy from “market-weight ” to “underweight “;
   
2. The S&P and its rival Fitch cut their outlook on India to negative last year, warning the country of a possible rating downgrade of its bonds to “junk ” as debt costs climb non-stop; and,
   
3. Sadly, on 6^th August, India slipped out of the elite global league of stock markets with a trillion-dollar valuation, as the total value of all its listed companies fell to $989 billion (US) amid huge selling pressure on the exchange.
   

Since April 2013,the beginning of the current fiscal year, because rupee valuation has fallen, the Indian stock market appears to have fallen by only about 4% but its dollar valuation has plunged by about 18 % (from $1209 billion to $989 billion).

Without new investments, these downgrades would possibly take India’s rating to below investment grade. This is forcing many existing domestic and foreign investors to sell their Indian securities. Indian corporations are currently more vulnerable to currency shocks than any time in recent history, given the sharp rupee depreciation in a short period and historically high currency volatility. The next 12-18 months are expected to be most challenging for Indian corporations.

Culturally, Indian citizens are obsessed with gold as it is an easily transferable asset and can be liquidated into cash anytime. Due to the economic slump and poor returns from planned financial investments (fixed deposits, bonds, Mutual funds, etc.) Indian gold consumption has spiked to an all-time high. This has also contributed to further depreciation of the rupee’s value.

Paradox: A Growing Economy with a Massive Poor Population

Despite India’s aspirations to be a global superpower, hundreds of millions of people do not yet have adequate access to food, clean water and basic sanitation. India ranked 65 out of 79 nations on last year’s Global Hunger Index and nearly half of India’s children under the age of five are chronically malnourished.

A recent report from the UN stated that a third of the world’s poorest people live in India. This is shocking considering it is one of the top five fastest growing economies in the world. While the government talks about focus on the poor in most of its initiatives, in reality the government’s economic policies have ignored them. India has one of the lowest public expenditures in the world (around 4.1% of GDP). No wonder India ranks 136th among 187 countries in human development index, placed at the near-bottom of countries which have reached ‘medium development’. One of the Near Government Organizations (NGOs) has published a report stating India is performing more poorly than sub-Saharan Africa in eradicating child malnutrition.

Still, India’s planning commission, ostensibly led by economists, has released a controversial report which says that people whose daily consumption of goods and service exceeds INR 33.33 (approximately $0.54 USD) in cities, and INR 27.20 (approximately $0.45 USD) in villages are not considered poor. The report said the number of people living below the poverty line has shrunk to 21.9% in 2011-12 from 37.2% in 2004-05 on account of an increase in per capita consumption. The definition of poverty is based on a methodology recommended in 2005 by a panel of experts headed by now-deceased economist Suresh Tendulkar. The methodology defines poverty in terms of consumption or spending by an individual during a certain period. This has led to a gross underestimation of poverty levels in India.

Meanwhile Rahul Gandhi, (a descendant of the Nehru dynasty), recently mocked the poor saying “Poverty is just a state of mind. It does not mean the scarcity of food, money or material things. ” With the ever-rising cost of living and high inflation, changing poverty line to prove the current government has uplifted people from poverty is seen by many as a government conspiracy and a mockery against the citizens of the country.

At the moment the government is trying every single avenue to stop our sliding currency value. Most of these measures have been ineffective. For example, the Finance Ministry and Reserve Bank of India has taken many measures attempting to curb gold imports, including increasing import duties, to discourage people from buying gold (and thus arrest the rupee’s value slide). Unfortunately, this has led to increased smuggling of gold.

People of India also speculate that the current economic situation is being manipulated to support a strong case to increase FDI to make it easy for people in power to bring money they have stashed abroad back into the country.

Shaky Political Climate

On one side, the UPA (United Progressive Alliance) government is busy indulging in questionable practices while carefully covering its tracks. On the other side, every step the UPA government has taken in the name of eliminating poverty or improving the life of common man has yielded minimal or negative results. Their efforts thus far seem to be only to secure votes of the poor people by making hollow promises on paper.

For example the National Rural Employment Guarantee Act (NREGA) introduced few years ago continues to be disastrous. Farmers are now complaining that it has decimated the rural agricultural workforce and ultimately reduced agriculture production. Under pressure from the World Bank, the government keeps cutting subsidies for agriculture, yet it is spending money on initiatives like NREGA. This is having double negative impact on farmers’ lives and agricultural output.

In a double standard, the current election commission wants to ban political parties who promise free goods and services to poor people (such as fans, TVs, etc.,) in their election manifesto as it can be considered bribing voters upon victory. Yet the ruling UPA party is announcing free cell phones to workers under the same NREGA which ultimately amounts to bribing poorer voters.

This lack of an available workforce is echoing across other labor intensive industries such as real estate. Companies have increased illegal immigration from neighboring Bangladesh to do the work. According to some estimates, India is host to between 20-35 million illegal Bangladeshi immigrants. Due to poor paperwork and tracking mechanisms, the government is forced to consider these illegals as residents and provide free access to all amenities that are provided to India’s poor citizens. The UPA government apparently sees this as an opportunity to win elections by legalizing their residency and converting them into voters.

Every single annual budget introduced in Parliament has favored only the rich by adding more burdens on the shoulders of the middle class. At present, the middle class, not the rich, bears the tax burden in India. On top of income tax value added taxes (VAT), the UPA government has introduced multi-layer taxes such as Service taxes, Education cess and Luxury taxes which add to their frustration.

Due to negative (or rather disastrous) economic and political developments, the UPA government has been criticized by the citizens (especially taxpayers) more than ever. With a focus on the upcoming 16th parliamentary election (due in mid 2014) ruling political parties are busy in damage control mode. This doesn’t help improve the situation.

Mall Business

Despite the slowdown in Indian real estate, the number of malls has doubled since 2008, from 225 to 570 as of May 2013. At least 60 malls opened across India’s metropolitan areas in the last year. Most malls that opened this year or the last were planned in 2005-06. At the same time, in the last two years 30-40 malls across the country have either been shut or have become non-functional. Also many of the long existing malls are considered to be a failure as they have lost their traffic to the new ones.

More than ever, Malls are performing poorly and retailers cannot sustain rents due to falling sales. Only 40% of the malls in the country are performing well. Vacancy in malls in the National Capital Region (the Delhi metropolitan area and surrounding urgan states) and Mumbai metropolitan region stood at 15-20 %. Mumbai and Chennai were the only cities to increase new supply in Q2 2013 but Mumbai also experienced the largest increase in vacancy. In some areas such as Navi Mumbai, vacancy rates are up to 30-40%. And these levels are not declining. In fact, they may go up.

Seven malls, totaling 2.58 million sq. ft. of selling space, were scheduled to be completed in Q2 2013. However, developers have sought to delay these projects by 3-6 months in the hope that demand for retail space improves from current levels.

Brick and Mortar Retail

Indian retailers shelving expansion plans, reducing headcount, revising strategy, or delaying plans for alliances with foreign partners has become an almost daily occurrence. Just a year ago this high potential sector was bustling with activity; everything indicated an oncoming boom. With so many players, competition was intense and predictions of consolidation or a decline, if at all, were five to eight years out. But, due to the global economic crisis and the Indian government’s policy paralysis, the Indian retail market decline is already upon us.

Indian retail companies, especially brick and mortar players are going through tough times. Even most of the top10 domestic players have bleeding bottom lines. Over the past year, even the more successful retailers such as Shoppers Stop Ltd and Lifestyle International Pvt. Ltd have seen a drop in growth as a weak economy and high inflation hurt demand on the one hand and rising rental costs and wages dented margins on the other.

India’s leading mega-corporations like Reliance, Tata, Aditya Birla and Mahindra ventured into the retail business with ambitious growth plans. Most multi-format retail outfits expanded at a too-rapid pace. Now retailers who expanded recklessly are closing many of their stores.

For example, Mahindra Retail (by Mahindra group) started in 2009 and expanded to over 115 stores earlier this year. The company initially opened stores as large as 7,000-10,000 sq. ft. Now, a majority of its stores are around 3,000 sq. ft. Recently Mahindra Retail (Mom & Me and Beanstalk brands) announced plans to shut more than 10% of its stores and cut costs after its ambitious expansion led to rapid cash burn and losses. Many of the senior executives of these chains have left their companies during recent months.

All major retail houses continue to focus only in urban markets, as cracking rural markets has turned out to be a tough task for them. Rural retail chains such as ITC’s Choupal Saagar and Godrej-Future Group joint venture Aadhaar also have faced tough times. This is primarily due to poor back-end infrastructures, demand fluctuation, local competition, and higher overhead and inventory expenses (especially cost of moving goods to deeper into rural areas). Farmers and rural residents want to understand the value proposition of brands in terms of cash savings and ease of product or service procurement. To be successful in rural business, the retailers need to understand the income-expenditure cycle of farmers and link it to their products and services.

Online Retailing

India’s e-commerce retail sector is caught in an atypical bind. On the one hand, the online sales of goods are accelerating, as people are acclimatized to buying things online. But on the other, the government’s decision in September to bar foreign direct investment (FDI) in the online retail business has led to some amount of desperation among shopping sites, especially the smaller ones.

India’s budding e-commerce market is choked due to depressed valuations, lack of funding and confusion over regulations. Online retail still only accounts for a minuscule $600 million, compared with India’s $518 billion brick and mortar retail industry. As per various reports, Indian e-commerce sector has a potential to grow to as much as $76 billion by 2021.

In 2012, the government said it would neither allow FDI in any consumer facing retail business conducted online, nor would it allow private equity (PE) or venture capital (VC) funds to directly invest in e-commerce companies. Subsequently, the Enforcement Directorate began to probe Flipkart, India’s biggest online shopping site, funded by PE firms. With companies burning cash on chasing customers, investors PE and VC firms aren’t convinced the model is sustainable and are cutting back on investing in start-ups.

Later the government said that e-commerce firms can operate as so-called independent marketplaces (the model being eBay.in and Amazon.in). After the rules were announced, FlipKart and many other online retailers converted to these marketplace structures.

Of the 53 e-commerce companies that got $853 million in venture capital over the past three years, only 11 have managed to raise further rounds of funding. The rest are struggling to scale and a few even are asking the larger players to take them over.

FDI & Retail

India’s total Foreign Direct Investment (FDI) inflows rose over 10 times to $166.7 billion in 2000-12 from $16.6 billion in 1991-00. FDI in industry kept pace with the total FDI inflows and increased 10 times to $81 billion from 8.1 billion over the period. While this may paint a rosy picture by comparing the current numbers with that of a decade ago, the current market conduciveness looks thorny.

FDI in India is subject to certain rules and regulations and is subject to predefined limits in various sectors, ranging from 20% to 100%. Last month the UPA government approved the recommendations given by a committee to increase FDI limits in 12 out of the proposed 20 sectors, including crucial ones such as defense, Retail and telecom to boost inflow of foreign money in a bid to revive the economy and control current account deficit.

Though the current size of the India retail market is USD $500 billion and is poised to reach USD $1.3 trillion by 2020, India has lost its sheen as an attractive destination for retail business. This year India slipped from the 5th to the 14th position on the Global Retail Development Index for 2013. Considering multiple factors like the current political situation, economic volatility and widespread corruption, India has been rated as a medium risk market. Infrastructure Issues, electric power deficits, low consumer confidence, weak currency, high Inflation and high tax rates add to the problem.

FDI in single brand retail is to be allowed up to 49%. Ownership beyond that percent can be appealed through the Foreign Investment Promotion Board (FIPB). Last week, the government diluted many contentious conditions in the traditional multi-brand retail FDI norms including 30 % sourcing from small firms, 50 % investment in back-end infrastructure and access only to cities with over one million population.

Government interference and resulting opacity have bred a culture of corruption. It has been estimated that the total bribes paid by urban adults is equal to 6.3% of India’s GDP. Unfortunately, in lands where bribe-paying is considered normal behavior, multi-national corporations (MNCs) that are keen to grab a piece of an apparently lucrative pie have little choice but to indulge in those malpractices.

Bharti Retail, the current JV partner of Walmart in India has returned 17 properties which it had leased across the country to open Easyday stores back to landlords. This is caused by a newfound reluctance of ally Walmart to engage in front-end retailing in India. Walmart is conducting an internal probe to check if its Indian unit violated US anti-bribery laws. It does not want to open stores until it is able to put in place a fool-proof compliance mechanism, and avoid a repeat performance of what happened in Mexico.

Walmart feared the process of procuring the dozens of licenses needed to open stores in India would involve practices that would violate provisions of the US Foreign Corrupt Practices Act (FCPA). Retail executives in India say it is hard to procure most licenses in India without greasing the palms of government officials and politicians. Walmart’s apparent lack of enthusiasm for Bharti Retail’s expansion program has also put the spotlight on the future relationship between the two companies.

The issue of FDI in multi-brand retailing may face rough weather in Rajya Sabha (the upper house of the parliament), when a statutory motion on the matter is taken up for vote in the current session. Many state chief ministers have reiterated that FDI in retail will not be allowed in their states.

Even the major opposition party BJP (Bharatija Janati Party,roughly translated to “The Indian’s People’s Party “) leading the National Democratic Alliance (NDA) accused the UPA government of surrendering to global retailers like Walmart by diluting the norms for FDI in multi-brand retail and promised to do away with such “flip-flops ” in economic policy making if voted to power. They have also promised to reverse most the FDI decisions that may impact the small players in the market.

Even though the government has partly addressed their concerns and relaxed the norms, international retailers like Walmart, Carrefour and Tesco are unlikely to enter the supermarket business in India before the 2014 general elections.

Conclusion

Indian retail is currently going through rapid expansion and hard churn. Not many are making money, but all are gung-ho about the future. In fact, many existing players are looking for opportunities to sell their operations to multinational retailers who may enter into the market.

With a country like India seeking massive foreign investments, it would have been good if those MNC’s collectively had taken an anti-bribery stand and exposed those who demand bribes from them.

With the gloomy days ahead, has India lost its sheen as a retail hub? Currently, unfortunately the answer is “Yes “. But it definitely will bounce back post 2014, provided a stable government comes to power with a clear vision of economic growth. Till then, whether FDI or not, it will continue to be a wait and watch game for international retailers.