30% local sourcing curbs retailer play

After playing to the tunes of allies and coalition partners for almost a month, the government took the bold step of notifying 100% foreign direct investment (FDI) in single-brand retail in India.

This means global brands such as Gucci, Tommy Hilfiger, Zara, Adidas, Nike and others can set up fully owned businesses — till now, they had to have an Indian partner who held 49% stake.

But what skews this milestone development, retailing experts say, is the 30% rule — where foreign companies have to source nearly a third of their products from Indian ‘small / village and cottage industries, artisans and craftsmen’ if they want to go purely solo.

“I really do not understand the logic behind the 30% local sourcing pre-condition for foreign single-brand retailers looking to set up operations in India. It is like saying we are open to investments but you cannot really invest. It clearly shows the government doesn’t really understand the concept of single brand retailing,” said a top official from a leading retail consulting firm in India, who did not wish to be named.

The caveat defines small industries as those with a total investment in plant and machinery of around Rs5 crore. This valuation refers to the value at the time of installation, without providing for depreciation.

Further, if at any point in time, this valuation is exceeded, the industry shall not qualify as a ‘small industry’ for this purpose. The compliance of this condition will be ensured through self-certification by the company, to be subsequently checked, by statutory auditors, from the duly certified accounts, which the company will be required to maintain.

“This basically also means that the government doesn’t really want the small industries to grow their business and remain where they are forever,” added the official.

Arvind Singhal, chairman of Technopak Advisors, feels while the pre-condition may work for a handful of categories, it’s a hurdle for a whole lot of others where local sourcing is not really possible at least in the first few years of setting up front-end operations in the country.

“What the government could have done instead is make it mandatory for such retailers to export 30% - 40% of the value of their overall sales generated from the Indian market. This approach would work faster compared with what has been put together at present,” he said.

Anil Talreja, partner, Deloitte India, said companies which already source locally can be in a sweet spot but concurs others may have to relook at their expansion strategies.

“This may also lead to staggered buyouts or giving away the sourcing part to its Indian partner,” said Talreja.

Govind Shrikhande, managing director, Shoppers Stop, said retailers operating in categories such as bed linen which are already sourcing from India will be the key beneficiaries.

“However, luxury goods retailers will not be able to source from India because they have to maintain global standards for their brands and hence manufacture it from a single location. Such players will continue to operate the way they have been doing thus far,” he said.

Terming the government’s decision a move in the right direction, Kishore Biyani, founder and group CEO, Future Group, said, “Going forward, increased level of activity can be witnessed in categories such as home and apparels.”

Kumar Rajagopalan, CEO of Retailers Association of India (RAI), says larger fashion houses (without India sourcing) will have to start looking at ways to comply with the 30% condition if they want to set up beachheads.

The government first allowed 51% FDI in single-brand retail in 2006. In four years since, India drew close to $200 million in FDI.   

Government figures show there are as many as 94 proposals for FDI with the government of which 57 have been approved so far.
“This is expected to rise exponentially now,” said Harish Bijoor, independent retail consultant. The 30% sourcing rule, according to him, will only expand the time between ideation and incubation of businesses.

According to Sageraj Bariya, managing partner, Equitorials, a Mumbai-based equity research firm, another plus point would be that foreign brands that are already in India will be able to take quicker business decisions and therefore make more investments since they will not have to wait for their partner’s ability to raise funds.