FDI in Retail - A bold move by Indian Government

Overview

In a bold and in all likelihood, a controversial step, the Union Cabinet has finally permitted 51% FDI in Multi-Brand Retail Trade (MBRT) and up to 100% FDI in Single Brand Retail Trade (SBRT) both with Government approval. The existing policy prohibits FDI in MBRT and limited FDI in SBRT to 51%.

The Department of Industrial Policy and Promotion (DIPP) had circulated a draft note to seek inter-ministerial and public views on this politically sensitive issue. Some of the key features of the policy liberalization as stated by the government note are as follows:

MBRT - 51% under approval route (prohibited presently)

The proposal for 51% FDI in MBRT has been permitted under Government Approval route with the following riders:

• Fresh agricultural produce and meat products may be unbranded. The Government has the first right to procure agricultural products. Given that there are significant losses due to poor storage facilities for produce acquired by the Government, this may be a precautionary condition in order to ensure food security;
• Minimum FDI to be brought in is USD100 million. It is important to note that the period over which this amount is to be brought in has not been specified;
• At least 50% of the total FDI must be invested in ‘backend infrastructure’
• The term ‘Back-end infrastructure’ has been defined to include capital expenditure on all activities, excluding that on front-end units; for instance, it will include investment made towards processing, manufacturing, distribution, design improvement, quality control and packaging, amongst others. However, the cost of land and rentals are excluded for this purpose.
• It is pertinent to note that only capital expenditure (excluding front end) is covered in the definition of ‘back-end infrastructure’ thereby implying that the cost of maintenance of such infrastructure will not be counted towards this limit;

• At least 30% of the procurement of manufactured and processed products should be sourced from ‘small industries’;
• The above limits are required to be certified by statutory auditors;
• Retail stores to be set up only in cities with population of more than 1 million. 53 cities presently qualify out of a total number approximating 8000.

SBRT - 100% under approval route (existing 51% under approval route)

In light of the fact that the total FDI in SBRT since 2006 has not yet touched USD50 million, the existing cap of FDI in SBRT has been enhanced from 51% to 100% under approval route. The relaxation is intended to significantly increase the FDI inflow in SBRT. The conditions attached to SBRT are as follows:

• Products to be sold should be of a ‘single brand’ only;
• Products should be sold under the same brand name internationally;
• ‘Single Brand’ product retailing would cover only those brands which are branded during manufacturing
• The foreign investor should be an owner of the brand;
• For FDI beyond 51%, 30% sourcing  would mandatorily have to be done from SMEs/ village and cottage industries artisans and craftsmen.  Other than this rider, the four conditions mentioned above were currently apply to FDI in SBRT.

 Condition of 30% sourcing from small scale sector

• 30% sourcing is mandatorily required from micro and small enterprises with plant and machinery up to USD1 million (SME).
• The stated intent of this requirement is to ensure that the Indian SME sector benefits, including artisans, craftsman, handicraft and the cottage industry. Given this intent, it is unclear why sourcing has been permitted from SMEs anywhere in the world and not just in India.
• This condition is applicable both for MBRT and for SBRT where FDI exceeds 51%.

While the exact impact of the above policy change will take a few years to unfold, the perceived advantages and disadvantages arising from the policy relaxation are expected to be as follows:

Advantages

• Significant employment generation
• Efficiency in supply chain coupled with capacity building and induction of modern technology
• Expected to contain food inflation, at least in the medium term by increasing its supply
• Will help the sector become more organised
• Securing remunerative prices for the farmers by ensuring direct procurement of agriculture produce
• Benefit of lower costs to consumers on account of increased competition

Disadvantages

• Potential labour displacement
• Disintegration of established supply chains by establishment of monopoly of global retail
• Adverse impact on domestic small and unorganised retailers

US Consumerism on Black Friday

The following news report http://www.cnbc.com/id/45428383 on how violence erupted in some stores in US on the occasion of Black Friday shopping day makes one sit back and rethink on US consumerism. 

Should I take this desperation by the citizens of the World's biggest consumer as a sign of Consumer Confidence and rising demand among consumers or does it tell a different story altogether. It could also be that this is a day when retailers pamper consumers with huge discounts and its only on this day that the middle class consumers of US can manage to buy some of these goods which they have been procrastinating for some time in current economic turmoil!!

We all know that jobless rates in US are currently at one of the highest levels in the history of the country in modern times. US has a $ 15 trillion GDP and nearly 55% of that is consumer spending. These very consumers are the ones who are keeping the machines running in far off China and Indonesia and keeping the techie awake in India. What would happen if this massive consumerism gradually declines? 

India and China definitely have 1/3 of the world population, but for them to replace the consumerism of US citizens, its a long way to go. India's GDP is currently $1.6 trillion and consumerism is a small portion of this. To replace the nearly $8 trillion US consumer market from the top spot, is a daunting task. The per capita income of USA is around $46,000. Compare this with the per capita income of China which is at $ 7,500 and India's which is $ 3,400. More importantly the proportion of people who are earning below this national income level is way too high in India and China. The huge disparity in income levels tilts the table all the more. 

So basically it seems the World has to continue to depend on US consumers for a long time till India and China mature enough to shoulder the burden of World Consumerism.

Buffett's Big Move in Shaky Market

It indeed seems, the God of Value investing puts in practice what he preaches unlike most other so-called market experts who make their living out of preaching others about investing. The article summarizes where Warren has been investing amidst all the market turmoil. 

http://www.cnbc.com/id/45259772

Euro zone loses appetite for Italian Pizza!!

The year 2009-10 gave birth to a new abbreviation which increasingly became more and more important for the World economy. That abbreviation is PIIGS - Portugal Ireland Italy Greece and Spain. A pig is generally considered to be a dirty unwanted animal and so is this PIIGS too.  

While Portugal and Ireland managed to get some bailouts and survive in 2010, Greece which was a bigger mess, does not seem to be all that lucky. The EU, IMF and G-20 has asked the Greek government to adhere to the austerity measures imposed upon it. I don't know whether the austerity measures would have any impact on the finances of the country, but it really did change someone's life - the Greek Prime Minister's, who had to resign under pressure. France and Germany with their heavy exposure in PIIGS, were forced to come to the rescue and also form the EFSF (European Financial Stability Facility) and convince G-20 and IMF about the bailout needed for Greece. For the time being it seems Greek default has been averted though.

When the world was taking a breather from the Greek drama over the past few weeks, Italian bonds seem to have given a rude awakening to the World at large. Italy is a much bigger economy than Greece and any run on the Italian bonds would be in effect a test for the survival of the entire European Union. France and Germany are not in a position to bailout Italy. I feel Italy may need to exit the Euro zone and revert to its own national currency to resolve its debt crisis, thereby forcing the break-up of the Euro zone.

With yields on its sovereign debt hovering around the 7% mark, market access may become limited for Italy. A forced restructuring of its debt could help solve some of its issues, but it would not address other issues that hamper the Italian economy such as a lack of competitiveness, a large current account deficit and lower gross domestic product. 

Neither the EFSF nor the IMF is in a position to bailout larger economies like Italy. Issuing more bonds in the Euro zone by the EFSF would lead to a larger pandora's box which would create bigger problems in the years to come. Its like a gigantic leveraged CDO being financed by the better performing nations and large emerging economies. Its a recipe that would leave a bad taste in the mouth. 

As I had mentioned in my previous blog why government austerity measures are not a great idea Italy is facing recessionary pressures on account of the cut in government expenditures. This would definitely make the high sovereign debt unsustainable. The only way to avoid a breakup of the Euro zone would be for the European Central Bank to become a lender of last resort, for a fall in the euro's value in line with the dollar and for fiscal stimulus for the "core" euro zone and austerity in the periphery to take place. Till this takes place, it seems Europe's fancy with Italian Pizza is done for the time being!!

Indian Railways - reminiscent of our past

Few weeks ago I had an opportunity to make a train trip to one of the most beautiful beaches in India. After ruling out lot of options we decided to make the overnight journey by train. I was anxiously looking forward to it as its been nearly thirteen years since I last traveled by The Indian Railways.... over these years as I grew up and graduated, post graduated and got myself more involved in the capital markets, I read a lot of how the dynamic railway ministers like Laloo Prasad Yadav had turned around the Indian Railways for the good. Even Harvard Business School had invited Mr Yadav to give a guest lecture on how he turned around the second largest employer in the World (for those who don't know, Indian Railways is the second largest employer in the World, after Walmart!!!).

But what really prompted me to write here is the fact that nothing seems to have changed in the last 13 years!! Definitely a lot many trains would have been added on newer routes but the quality of service and train journey remains the same. You still see the cockroaches in the cabins, the blankets, pillows and sheets still are not the most hygienic to be used and not to mention the same sorry state of the toilets.

I loved the food that used to be served in the trains in my childhood days as it gave me a feeling of an adventure outing, a change from the healthy home food. The menu hasn't really changed much in these 13 long years!! You still get the cutlet bread with butter and sauce for veggies and omelette bread for the non-veggies. The ubiquitous idli-vada sambhar chutney also has not lost its place from the menu options. The chai-chai-chai monotone immediately takes you back to your childhood days when the sound of bottle opener being swiped on cola bottles used to immediately lighten up the eyes knowing the cola man was coming...

In a way I feel the Railways have definitely preserved our past for the generations to come ahead. In our fast paced life when we don't think of any other option other than taking the flight in order to save time, I think one should make a train trip once in a while to feel the roots and also see the country side of the heartland. But nevertheless I think the government should take up a separate project to modernize the Indian railways. High speed trains like the ones that are a common sight in Europe and even our Asian neighbours of Japan and China should be introduced here. Heritage railways should be preserved separately!!

Higher taxes for Wealthy Americans

There is news that US President, Barack  Obama would be proposing what is being called as "Buffett Tax" on people earning more than $1 million a year as part of his deficit-cutting recommendations to the US Congress.

The purpose for such a tax is to bring the tax rates of the wealthy Americans in line with that being paid by the middle class Americans.  Warren Buffett had once famously said that he thinks that he, and other super-wealthy Americans, don't pay enough in taxes. He said his tax rate is 17.4% whereas most middle class Americans pay 30% or more in income tax. It’s really an irony that cannot be explained by simple economics!

No wonder Capitalist America took it so long to realize as to who needs to be taxed more and who less. Taxing the rich and leaving a little more extra cash in the hands of the middle class could definitely change the dynamics of local consumption significantly. It’s vanilla economics, that the marginal utility of a few thousand dollars in the hands of a middle class is much more than that in the hand of billionaire!

In his weekly radio address Obama said that Americans need to be ready to "pay their fair share" to narrow the U.S. deficit, previewing his proposals to Congress. Obama has repeatedly argued for the wealthiest Americans to face higher taxes with fewer loopholes and exceptions as part of the effort to ensure the U.S. debt-load remains in control. In addition to floating the idea of more taxes on the rich, he is also expected to propose companies getting some tax breaks.

It’s no wonder that the Republicans, who have raised the volume on Washington's fiscal problems as the November 2012 presidential election nears, see higher taxes on the wealthy as a problem for jobs, given that entrepreneurs and companies would be strongly affected. It’s really an unfair world where the rich would go to any length to arm-twist the government in preserving their wealth whereas the middle class has difficulty in even building a cushion for tough times.  

Why Government austerity measures are not a great idea

The current global crisis has given governments a new weapon to tackle the precarious situation being faced by them - Austerity measures. Financial times lexicon defines Austerity measure as "An official action taken by a government in order to reduce the amount of money that it spends or the amount that people spend". But doesn't classical economics teach us that in order to come out of a recessionary economy there needs to be increased spending and consumption demand in order to stimulate industrial activity?

US President, Barack Obama announced a $ 447 bn package that would create jobs in the economy through infrastructure spending and government spending. This is definitely a step in the right direction, unlike what governments in Europe are resorting to. Cutting down government spending, pensions and salaries would see its repercussions over a longer period of time. It needs no economist to tell you that these activities would lead to lower local consumption, lower industrial activity, more job cuts and the cycle would get more painful with time.   

What really is needed is a change in habits of the people. Though a difficult thing to ask but then difficult times need difficult measures. This change in habits is something that would come with time. The concept of savings and spending within your limits is something the Europeans need to learn from the conservative Asians. Leverage and Debt is the single most important cause of all problems that the world is faced with now. Asians are known to be conservative investors and that has definitely helped them to sail through the current turmoil. Indians in general have a very high savings rate of 33% of their earnings. I think its not asking for too much if one is advised to spend within their limits. 

By austerity measures, governments are punishing the common man for the wrong doing of the politicians and the financial market culprits. People could also vent their anger through protests and strikes like the ones seen in Greece recently. These cannot be suppressed for long and has the power to topple governments. Instead of passing the buck of austerity on the common man in Europe, it is important to bring the bankers and financial engineers under some sort of regulation wherein a check must be kept on the leverage these guys are taking on their banking assets. Greed for higher returns and commissions has rocked the ship earlier and would do so again in future unless there is some check to keep these in limits. Investment bankers and Wall Street bonuses which defy gravity even in recessionary economy is a clear indication that the very systems which run and govern the Zillion Dollar global banking and financial markets have inherent flaws that is working in favour of a few and against the majority.