Editor: Foreign direct investment (FDI) in India has been opened up in many areas, but left restricted in others. Where is it still limited, and what is the rationale behind this decision?
Patel: In August 2013, the FDI policy was liberalized with respect to several sectors, such as in telecom services where FDI up to 100 percent has been permitted (previously 74 percent). However, in a number of sectors, FDI remains restricted for different reasons – for example, (i) uplinking of news and current affairs TV channels and publication of newspapers and periodicals dealing with news and current affairs are still regarded as “sensitive sectors,” and restricting FDI is believed to be a way to regulate content; similarly, defence is a restricted sector in the interests of national security; (ii) investment in multi-brand retail continues to be restricted due to strong political opposition; and (iii) FDI in the insurance sector, while proposed to be increased from 26 percent to 49 percent, is pending the approval by parliament of the Insurance Laws (Amendment) Bill, 2008.
Editor: Last year at about this time, the Indian government announced a change to its policies on FDI in multi-brand and single-brand retail trading. Would you outline these policies?
Patel: First, some background. 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. In November 2011, 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. That proposal produced considerable backlash so the Indian government limited its liberalization policy to only 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. FDI in multi-brand retail continued to be prohibited until September 2012, when FDI up to 51 percent was finally permitted in multi-brand retail, with the prior approval of the FIPB and subject to various conditions that (a year later) appear to have had an unfortunate chilling impact on the attempt at liberalization. FDI in single-brand retail trading was, on the other hand, further liberalized in August 2013 when FDI up to 49 percent was permitted under the automatic route, with FDI in excess of 49 percent and up to 100 percent requiring FIPB approval.
Editor: What are the conditions for 100 percent foreign ownership in single-brand retail companies, and how successful have single-brand retailers been thus far?
Patel: The following must occur:
Sethi: Since 100 percent FDI in single-brand retail trading has been permitted, there has been significant interest from foreign retailers who are keen to capitalize on the large Indian market. The FIPB has since approved the applications of companies across various product lines – IKEA, Fossil, Decathlon and Le Creuset, to name a few. The 30 per cent sourcing requirement has been a stumbling block for a number of companies, including IKEA. Though the Indian government has modified the requirement to make it somewhat less stringent (the sourcing should preferably be from small scale/cottage industries/craftsmen and is to be initially complied with over a five-year period), it remains of concern to numerous companies.
Editor: Please describe the limitations on investments under the multi-brand investment policy, especially the requirement that retailers obtain 30 percent of the procurement value of manufactured/processed products from “small industries.”
Sethi: FDI of up to 51 percent in multi-brand retail is permitted subject to FIPB approval and the following conditions:
Editor:The joint venture between Wal-Mart and Bharti was recently called off, with Wal-Mart purchasing Bharti’s 50 percent stake in the Indian wholesale venture. It has been reported that the regulatory framework you described may have played a role in this decision. Would you elaborate on this?
Patel: In addition to the termination of the wholesale cash-and-carry venture with Wal-Mart buying-out Bharti’s stake in the joint venture, news reports also indicate that Bharti will acquire the compulsorily convertible debentures held by Wal-Mart in Cedar Support Services (the holding company of Bharti’s retail venture). The retail venture was investigated in March 2013 for violation of the FDI norms (news reports suggest that it has since been found that there was no violation). Based on news reports, it appears that the 30 percent sourcing requirement became a significant roadblock for Wal-Mart’s plans to expand into multi-brand retail. Under these regulations, the Indian government is mandating that large global retailers plug the very smallest business partners into their procurement, logistics and sales systems. Setting aside the practical problems this creates – such as identifying, negotiating and reaching acceptable contractual terms with reliable small and local businesses – the economics will be very difficult to make work for the foreign retailer. In other countries, these large retailers will leverage their ability to establish significant, multi-location and long-term agreements with sophisticated and reliable third parties to get comfortable that an appropriate return on their investment can be achieved. Under the Indian regulations, these factors are harder or impossible to achieve and the ability to make an acceptable return becomes even more difficult to accomplish.
Editor: In February 2013, authorities in the state of Tamil Nadu put a stop to the construction of a Wal-Mart warehouse, becoming the first state to strongly resist the new retail policies. What role do Indian states play with respect to enforcing or resisting national policy?
Sethi: The “sealing” of Wal-Mart’s proposed warehouse in Tamil Nadu was stated to be due to the absence of necessary building approvals and permits. While the ostensible reason was unauthorized construction, policy-level concerns were expressed by traders and other stakeholders in Tamil Nadu regarding the entry of foreign retail giants into Tamil Nadu.
With respect to multi-brand retail, the implementation of the FDI policy has been left to the discretion of each individual state. As on date, 12 states/union territories in India have agreed to allow FDI in multi-brand retail. States such as West Bengal, Kerala and Tamil Nadu continue to oppose the policy. The economic and social benefits that could be expected from foreign investment in the retail sector, such as job creation, increased competition and a consequent reduction in prices and better supply chain and logistics, are viewed with skepticism in such states.
Editor: In July, Mauritius responded that it would address India’s concerns that its double tax avoidance agreement (DTAA) with the island nation was being abused. What was the problem, and has the DTAA been revised?
Sethi: The DTAA between the two countries provides that capital gains arising in India from investments into India from Mauritius can only be taxed in Mauritius. Since Mauritius does not tax capital gains, Mauritius became an attractive destination for foreign investors to route their investments into India. A revised DTAA is under negotiation and has not been finalized as yet.
Editor: U.S. companies entering the Indian retail space may encounter heightened FCPA risks. What are some best practices for mitigating this?
Patel: You are correct. Some of the basic provisions of the retail regulations (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 precautions to mitigate their FCPA compliance risks associated with proposed Indian retail investments, including: