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FDI fineprint: Easing FDI doesn't ease problems plaguing retail

Is the market rejoicing the cabinet approval for retail FDI (foreign direct investment) a bit too soon? The fine print of the proposal suggests so.

The Cabinet on Thursday approved 51 percent FDI by multi-brand retail companies and raised the limit for single-brand retailers to 100 percent from 51 percent.

Narayanan Ramaswamy, executive director, KPMG India, was quoted by Bloomberg as saying that the the moves offered "one of the biggest opportunities in the world right now". A $450 billion retail market has been opened for foreign investment.

 FDI fineprint: Easing FDI doesnt ease problems plaguing retail

The single brand retailer has not taken advantage of the 51% that exists, why will 100% make a difference? Reuters

Retail stocks have shot through the roof after the proposals received cabinet approval. Pantaloon surged 16 percent higher, while Vishal Retail hit the upper circuit of 20 percent at Rs 22.70. Trent is trading 9 percent higher at Rs 1,064. Even single-brand retailers like Koutons and Provogue have gained.

However, there is very little reason for single-brand stocks to go up. First of all, they have not been able to garner any FDI even when the limit was 51 percent. Secondly, with 100 percent FDI in the sector, these companies will be faced with increased competition as foreign brands will now be setting up outlets next to theirs.

As for multi-brand retailers, a number of issues still remain to be tackled. The first is that individual state governments have the power to veto foreign retailers. Along with the opposition, even some members of the ruling Congress have opposed the move. That leaves the market open for investment in only a few states.

The second problem is the issue of the 51 percent stake in these companies. Currently, most of these companies havestretchedtheir finances. Take Pantaloon for example, interest outgo accounts for over 60 percent of its operating profit, leaving very little free cash for growth.

A strategic investor (read a big retailer) will be unlikely to invest in such a company because his money will probably be used for paying off excess debt without creating any new capacities. Also, they will be more willing to invest 51 percent and take control of the operations. Very few Indian promoters, in contrast, will be willing to relinquish management control. Pantaloon, in fact, has a poor track record of managing joint ventures.

Anand Sharma, minister of commerce and industry, in his press conference said that the move will benefit farmers as they will get a benefit of better realisations. The few retail chains that sell farm products, no doubt, sell their products at lower- than-market prices; however, their procurement strategies are even more aggressive than those employed by traders of the Agriculture Produce Market Committee (APMC). So it's extremely unlikely that farmers will actually benefit from the FDI investments.

The only way the huge gap between the price at the farm gate and at the shop can be bridged is by allowing the farmer to sell his own produce. Currently, they have to pay a deposit of Rs 1 crore, just to get a licence to sell in the bigger APMCs.

But agriculture traders will ensure that farmers never get the opportunity to sell on their own. In the past, some stores of Reliance Retail were, in fact, ransacked by traders, forcing the company to shelve their expansion plans in certain states.

Players who, however, are just setting up their retail chains or are in the nascent stage of growth like Bharti will benefit from this FDI move. In the case of current players, they can at best hope to rope in a private equity player to pick up a sizeable chunk of their equity.

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Updated Date: Dec 20, 2014 05:24:44 IST