DIPP Clarifications – Government’s ambitious wish list for foreign retailers changes the game for stakeholders

More than six months after opening up the enviable Indian multi-brand retail sector to foreigners, the Department of Industrial Policy and Promotion (DIPP) issued a series of clarifications in connection with the multi-brand retail FDI policy on June 6, 2013. The announcement triggered strong reactions on the part of potential foreign investors as also Indian businesses seeking to partner with them in the retail space. What do these clarifications really imply for potential investors? How do they affect the interests of the Indian business community? Has the Indian Government gone into overdrive on the protectionist approach? This post analyses the key ‘clarifications’ which have effectively modified the original policy, and explores how they have changed the game for stakeholders in this sector..Source, but don’t distribute.The original policy mandates a foreign retailer to procure processed goods worth at least 30% of its total procurement of such goods from ‘small industries’ in India (commonly referred to as the 30% sourcing rule). The DIPP has now announced that foreign retailers cannot distribute such goods onward, except through their Indian retail stores. For instance, if a retailer, say Walmart, procures processed meat from a small industry under the 30% sourcing rule, Walmart can only sell this meat through its own retail stores in India, and cannot sell it to another retailer nor can it export it. Whilst the intent of this condition would be to ensure distribution of local goods through the big retail chains, it will inevitably result in market distortions by clogging retail stores with goods having an unpredictable or negligible demand. Moreover, the prohibition on export of such local goods by foreign retailers will deprive small industries of the price that they could have commanded in the export market and an effective distribution channel for exporting their products..Back-end infrastructure to be greenfield.The original policy requires foreign retailers to invest at least 50% of their total investment in ‘back-end infrastructure’ such as facilities for processing, manufacturing, distribution, warehousing, logistics, etc. The DIPP has now imposed an additional condition mandating foreign retailers to establish such back-end infrastructure afresh. In other words, if a Tesco acquires the assets or shares of an Indian company having an existing packaging business, the expenditure made by Tesco towards such acquisition will not be counted for the purposes of the 50% requirement. The obvious intent of this requirement would be to facilitate creation of new infrastructure facilities within the country. The flipside, however, is that it deflates the expectations of many Indian back-end businesses, which were seriously considering tying up with foreign retailers for back-end services. It also strikes at the heart of the business model of foreign retailers who typically outsource a large component of their back-end infrastructure. Also, it may not be viable for a new entrant to invest hugely in greenfield projects which do not form part of its core business..Back-end infrastructure for captive use only.The DIPP has now mandated that back-end infrastructure developed by foreign retailers in India can be used for servicing their own retail business only, and cannot service their affiliates or third parties. This prohibition further renders a greenfield back-end infrastructure project financially unviable for a new entrant. Moreover, given that 100% FDI is allowed in back-end infrastructure under the FDI Policy, the DIPP has not offered any explanation for prohibiting foreign retailers from supplying infrastructure facilities to third parties..Company owned, company operated.The DIPP has prohibited foreign retailers in India from granting franchises of their stores to any other Indian entity. This condition may not affect large retailers who have the financial wherewithal to own and operate stores throughout the country. However, it effectively blocks mid-sized retailers who wish to access the Indian market but do not have resources at the outset to establish a pan-India presence, and stifles any possibility of local entities benefitting from such franchises. Further, a blanket clarification that the retail stores are to be company owned and company operated questions the ability of the foreign investor to grant a license allowing the Indian company to continue operating the chain even after the investor’s exit..States may impose more conditions.The DIPP has further announced that State Governments are free to impose additional conditions on foreign retailers with respect to their investment in the concerned State. Accordingly, investors in this sector will have to factor in a series of unknown conditions that may be imposed by different State Governments. This, despite the fact that although more than 6 months have elapsed since the policy was announced, none of the States have begun to set up infrastructure to entertain applications from foreign retailers or devised guidelines governing this sector within the State..Despite the initial hullabaloo over the Indian retail sector and the reported desperation of foreign retailers to tap the Indian retail consumer base, partial liberalization of this sector has not yielded the desired results for the Indian economy. Whilst this may be due to the general cautious tendencies exhibited by investors globally, it is also largely attributable to the ambiguity shrouding the policy since its inception. As if the flip-flops in announcing the policy in December 2011 and the conditionality of the policy on the States’ willingness were not enough to arouse suspicions of its durability, the multiple protectionist conditions now imposed by the DIPP may make it unviable to invest in the Indian multi-brand sector. From a broader perspective, the recent announcement is suggestive of the Government’s disinclination to effectively implement the policy, and perhaps also of the colonial hangover that still persists in the Indian psyche..You can also read Amarchand Partner, Kalpataru Tripathy’s views on the clarifications here..Bhargavi is a Mumbai-based Solicitor with experience in M&A, private equity and corporate practice in India. She is presently affiliated with the Program on the Legal Profession at Harvard Law School where she is researching on investment law and policymaking, and the interface between legal professionals and policymakers in India.