Continuing a trend of liberalizing foreign direct investment (“FDI”) in its retail sector, the Indian government announced in September further changes to its policies designed to permit FDI in multi-brand retail trading of up to 51 percent, subject to certain significant conditions, as well as further relaxation of its policies on FDI in single-brand retail trading.[1]  While these amendments were met with mixed reactions from commentators and business leaders both within India and globally, it appears that major retail institutions, such as Walmart, will move quickly to take advantage of the new policy permitting foreign investment in multi-brand retail trading. 

We expect U.S. retailers to closely examine the relaxed FDI policy and to utilize this regulatory shift as an opportunity to enter the vast Indian retail marketplace.  Considering even a limited sample of recent Indian demographic and market statistics, it is not difficult to see the potential opportunities available to U.S. retailers that are able to successfully navigate India’s FDI policies. 

• India’s population equaled approximately 1.2 billion people according to provisional 2011 census data,[2] compared to an estimated 315 million people in the United States as of October 2012.[3]
• According to the U.S.-India Business Council, there are approximately 300 million “middle-class” individuals with a purchasing power parity of US$30,000 per year.[4]
• The Indian retail sector is estimated to equal approximately US$500 billion and is expected to reach US$1.3 trillion by 2020, according to a September 2012 report by the Federation of Indian Chambers of Commerce and Industry and PricewaterhouseCoopers.[5]
• According to research from CRISIL, the overall Indian retail sector is set to grow at a CAGR of 15 percent from 2011/2012 to 2016/2017, while organized retail will grow at a CAGR of 24 percent over the same period.[6]
• According to the Indian Staffing Federation, the amended FDI retail policy is likely to create four million direct jobs and almost five to six million indirect jobs over the next ten years, making retail the largest sector in organized employment.[7]

However, in taking advantage of the new policy governing FDI in the Indian retail sector, U.S. companies must carefully balance the structural and other conditions placed on their FDI by the new policy while not losing sight of key U.S. regulatory considerations which continue to be of paramount importance in overseas joint venture transactions, such as compliance with the Foreign Corrupt Practices Act (“FCPA”).

Background

On September 14, 2012, the Government of India announced its revised policy on FDI in the Indian retail sector. Following this announcement, on September 20, 2012, India’s Department of Industrial Policy & Promotion (the “DIPP”), of the Ministry of Commerce & Industry, issued (i) Press Note No. 4 of 2012 relating to FDI in single-brand retail trading and (ii) Press Note No. 5 of 2012 relating to multi-brand retail trading[8] (together, the “Press Notes”). The Press Notes set out the amendments to India’s Consolidated FDI Policy dated April 10, 2012 (the “FDI Amendments”). 

Previously, India prohibited FDI in multi-brand retail trading at any ownership level and FDI was only permitted up to 51 percent in single-brand retail trading, despite earlier attempts at liberalization.  In November 2011, the Cabinet of India, the decision-making body of the Indian government, proposed an increase in the FDI limit for single-brand retail trading to 100 percent and allowing up to 51 percent FDI in multi-brand retail trading.  Unfortunately for foreign retailers, the Cabinet’s November 2011 decision produced a considerable political backlash in India.  Consequently, the Indian government reversed course and indefinitely suspended plans to reform the retail sector. 

Recognizing that the political backlash was focused on the multi-brand aspect of the proposed retail-sector reform, by Press Note No. 1 dated January 10, 2012, the DIPP notified the Cabinet’s decision to permit FDI up to 100 percent in single-brand retail trading, subject to the prior approval of the Foreign Investment Promotion Board (“FIPB”) of the Indian government and certain other conditions.  However, following the January 2012 changes, FDI in multi-brand retail trading continued to be prohibited. 

The New Policy On FDI In Multi-Brand Retail Trading: A Give-And-Take

As a result of the FDI Amendments, effective September 20, 2012, FDI up to 51 percent is permitted in multi-brand retail trading, with the prior approval of the FIPB and subject to the following conditions: 

1. The foreign investor must invest at least US$100 million in FDI.
2. At least 50 percent of the total FDI must be invested in “back-end infrastructure” within three years of the first tranche of FDI.  Back-end infrastructure includes capital expenditures towards processing, manufacturing, distribution, design improvement, quality control, packaging, logistics, storage, warehouse and agricultural market produce infrastructure.  However, “back-end infrastructure” will not include expenditures on land costs and lease payments.
3. At least 30 percent of the procurement value of manufactured/processed products must be sourced from Indian “small industries,” which is defined to mean companies where the total investment in plant and machinery does not exceed US$1 million. For purposes of this determination, it has been specified that the value of the plant and machinery at the time of its installation is to be taken into consideration, without providing for depreciation. If this value is exceeded at any time, the company will cease to qualify as a small industry (and products procured from such company will not be counted towards the 30 percent sourcing requirement).
   In the first instance, the 30 percent sourcing requirement will be calculated as a percentage of the average of the total value of manufactured/processed products purchased in the five years commencing on April 1 of the year during which the first tranche of FDI is received. Thereafter, this will need to be calculated on an annual basis.
4. The Indian retail company is required to confirm compliance with conditions (1), (2) and (3) by self-certification. The investors are required to maintain accounts duly certified by statutory auditors.
5. Retail sales outlets may be established only in Indian cities with a population of more than 1 million (as per the 2011 census) and may cover an area of 10 km around the municipal/urban agglomeration limits of such cities.  In states/union territories that do not have cities meeting this population criteria, retail sales outlets may be established in the cities of their choosing, preferably the largest city and can also cover an area of 10 km around the municipal/urban agglomeration limits of such cities. In each case, provision is required to be made for transport connectivity to, and parking facilities at, the retail sales outlets.
6. The establishment of the retail sales outlets must be in compliance with applicable state/union territory laws and regulations, such as the Shops and Establishments Act.
7. Fresh agricultural produce, including fruits, vegetables, flowers, grains, pulses, fresh poultry and fishery and meat products, may be sold unbranded. 
8. Companies receiving FDI are prohibited from engaging in any form of retail trading by means of e-commerce. 

Applications for FDI in multi-brand retail trading will be processed by the DIPP, which must determine whether the proposed investment satisfies these guidelines, before being considered by the FIPB for final approval.

The FDI policy on multi-brand retail trading creates an enabling framework, and the decision to implement the policy is left to individual state governments/union territories.  The policy had been agreed to by several states/union territories, including, Delhi, Maharashtra, Andhra Pradesh, Haryana, Rajasthan, Uttarakhand, Assam, Manipur, Daman & Diu and Dadra and Nagar Haveli. Certain other states, such as Kerala and West Bengal, have expressed reservations regarding the opening up of the Indian multi-brand retail market to foreign investment, and at this time it is uncertain whether such states will implement the policy. 

Changes To The Existing Policy On FDI In Single-Brand Retail Trading

The January 2012 policy changes permitted up to 100 percent FDI in single-brand retail trading companies, subject to the following conditions:

1. The products to be sold must be of a “single-brand” only.
2. The products must be sold under the same brand internationally (i.e., the products must be sold under the same brand in one or more countries other than India).
3. “Single-brand” retail trading would cover only products that are branded during the manufacturing process.
4. The foreign investor must be the owner of the brand.
5. In respect of proposals involving FDI in excess of 51 percent, at least 30 percent of the value of products sold must be sourced from Indian small industries, village and cottage industries, artisans and craftsmen.

Reservations had been expressed with respect to certain of these conditions, including with respect to brand ownership and the 30 percent sourcing requirement, since it was unclear how strictly the Indian government would interpret such conditions. Through the FDI Amendments, the Indian government made important changes to the January 2012 policy in relation to FDI in single-brand retail trading.

• The FDI Amendments have eliminated the requirement for a foreign investor in a single-brand retail trading company in India to be the owner of the brand.  The FDI policy now permits only one non-resident entity, whether the owner of the brand or otherwise, to undertake single-brand product retail trading in India for the specific brand for which the approval of the Indian government is obtained.  If the non-resident entity is not the owner of the brand, this entity must enter into a “legally tenable agreement” (e.g., a license, franchise, or sub-license agreement) with the brand-owner, a copy of which must be provided to the Indian government when seeking approval. The onus for ensuring compliance with this condition rests on the Indian retail company.
  This policy change has been useful, since foreign investments in India are frequently through a holding company structure, with some other entity within the investing entity’s group being the brand owner. However, it is unclear how a pure financial investor, such as a private equity investor, would satisfy the requirements of this condition.
• The FDI Amendments have also incorporated significant changes to the 30 percent sourcing requirement. Following the FDI Amendments, the requirement in respect of proposals involving FDI in excess of 51 percent is that at least 30 percent of the value of goods purchased (as opposed to the value of products sold under the January 2012 policy) must be from India, preferably from micro, small and medium enterprises, village and cottage industries, artisans and craftsmen, in all sectors.  In the first instance, the 30 percent sourcing requirement will be calculated as a percentage of the average of the total value of goods purchased in the five years commencing on April 1 of the year during which the first tranche of FDI is received. Thereafter, this will need to be calculated on an annual basis. The Indian retail company is required to self-certify compliance with this requirement, which must be subsequently confirmed by its statutory auditors from duly certified accounts.
  This policy change has provided greater flexibility to foreign investors in terms of their ability to procure goods from any Indian entity (and not just small scale enterprises and cottage industries). However, in order to control the quality and homogeneity of its products, especially in the case of niche products or products that are technology intensive, foreign investors would likely need to build production capacity within India, either in existing units or by establishing new ones.   
• Similar to multi-brand retail trading, it has been clarified that single-brand retail trading companies with FDI are not permitted to engage in trading their products through e-commerce. 

FCPA Considerations

While the FDI Amendments present new and exciting opportunities for U.S. companies to enter the Indian retail marketplace, they should cause companies to carefully consider their FCPA risk profile and compliance structure prior to taking action.  U.S. companies experienced with overseas transactions are not strangers to the FCPA, which has come to be known generally as the U.S. anti-bribery law that prohibits payments to foreign government officials to gain business or an improper advantage.  However, some of the basic provisions of the FDI Amendments, such as the foreign/domestic joint venture structure mandated for multi-brand retail and the back-end infrastructure investment and small industry procurement conditions, present areas for heightened FCPA compliance risk.   

U.S. companies should consider basic precautions to mitigate their FCPA compliance risks associated with proposed Indian retail investments following the FDI Amendments, including:

• thorough due diligence on their domestic multi-brand retail partners and close monitoring of the business and third-party relationships;
• developing joint venture agreements that include or require compliance certifications for anti-corruption laws and provide meaningful access to the venture’s books and records;
• education and training of joint venture personnel covering anti-corruption laws and policies;
• thorough due diligence surrounding, and the establishment of compliance safeguards and reporting mechanisms with respect to, the identification, negotiation and execution of the back-end infrastructure investments, focusing on relationships with possible foreign officials and third party agents utilized in this process; and
• putting in place compliance safeguards and reporting mechanisms with respect to the Indian government’s FDI approval process and the Company’s self-certification process under the FDI policy.

Conclusion

As evidenced by the FDI Amendments, it is clear that the Indian government intends to balance access to India’s vast retail marketplace with promoting local industries and creating infrastructure within the country.  As a result, the FDI Amendments present several areas that will require careful examination by U.S. companies seeking to take advantage of the Indian marketplace, including potential FCPA compliance risks. Notwithstanding these challenges, and the conditions under the FDI policy (compliance with certain of which could be onerous), it is expected that U.S. retailers will seek to establish a presence in India.