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Foreign Direct Investment Effects On Indias Retail Sector Economics Essay

Abstract

Liberalization of trade policies during the last one and half decade has led India to become an investment friendly country. Foreign direct investment (FDI) in this country assumed critical importance in the context of this liberalization. Though India is the tenth most industrialized country in the world, it is well known that it is mainly agro-based with around 70% population engaged in the farm sector. However, in the initial stage of liberalization, FDI was centered on the urban manufacturing sectors because of its civic infrastructure, labour availability, flexible taxation mechanism etc. The success story of FDI in these sectors is known to us.

For a long time there were efforts for FDI in the retail sector so that the trader can reap the benefit of FDI. Retail trade contributes around 10-11% of India’s GDP and currently employs over 4 crores of people. India is one of the biggest and fastest growing developing economies and has attracted the most investor attention in recent years. India Economic growth has transformed several sectors of the Indian Industry into globally competitive entities.

Strong macro-economic fundamentals, positive investment climate and sound business outlook drove the bullish trend. The results show that the Retail industry has recorded a robust growth during this time period and has created great opportunities for investment. Further, the research compares India with four other leading developing countries (Brazil, Russia, China and South Africa) during 2006-07 and concludes that India is one of the fastest rising stars among all these major emerging economies with its economic growth rate running at over 8% annually.(Economic Times, Feb 2007). In order to tap the true potential of the economy, the Indian government and financial community need to be pro-active in promoting the country as a safe destination for foreign Direct Investment, while at the same time ensuring that the vital interests of the economy are not adversely affected.

1. BACKGROUND OF THE STUDY

Retailing is the interface between the producer of the goods or services and the individual consumer who is buying this personal use. A retailer is one who stocks the producer’s goods and is involved in the selling process to the final consumer at some profit margin. As such, retailing is the vital link that connects the final consumer to the manufacturer and the distribution chain. Retail has become one of the fastest growing sectors in the Indian economy in the last few years especially since the economic reform process has taken root. This sector has become the epicenter of tremendous activity in terms of modernization, expansion, proliferation of international brands, numbers of retailers with enhanced focus on quality, information technology, scale of operations and value added processes. With the spurt of shopping malls across the country, organized retail has come of age in India. It is bringing a dramatic change in the functioning of the Indian Retail Sector by throwing up exciting opportunities.

1.1 Introduction

Globalization and Retail sector reforms in India have ushered in a sea change in the financial architecture of the economy. In the contemporary scenario, the activities in the financial markets and their relationships with the retail sector have assumed significant importance. Since the inception of the Retail sector reforms in the beginning of 2000’s, the implementation of various reform measures including a number of structural and institutional changes in the different segments of the Retail markets. It has brought a dramatic change in the functioning of the sector of the economy.

Correspondingly, researches are also being conducted to understand the current working of the economic and the organized market in the new scenario. Interesting results are emerging particularly for the developing countries where the markets are experiencing new relationships which are not perceived earlier. The analysis on Retail sector has come to the fore since this is the most sensitive segment of the economy and it is through this segment that the country’s exposure to the outer world is most readily felt. There are 11 million outlets as against 9 million in USA even though their economy is 13 times larger. According to KPMG’ survey, India has emerged as the top FDI destination offering a higher return on investment than emerging markets like Mexico, Brazil and even China.

Foreign Direct Investment (FDI) becomes a very sensitive issue, with arguments to support both sides of the debate. It is widely acknowledged that FDI can have some positive results on the economy, triggering a series of reactions that in the long run can lead to greater efficiency and improvement of living standards, apart from greater integration into the global economy. Supporters of FDI in retail trade talk of how ultimately the consumer is benefited by both price reductions and improved selection, brought about by the technology and know-how of foreign players in the market. This in turn can lead to greater output and domestic consumption. But the most important factor against FDI driven “modern retailing” is that it is labour displacing to the extent that it can only expand by destroying the traditional retail sector.

FDI in the retail sector are not without some merit, it is not fully applicable to the retailing sector in India, or at least, not yet. This is because the primary task of government in India is still to provide livelihoods and not create so called efficiencies of scale by creating redundancies. As per present regulations, no FDI is permitted in retail trade in India. Allowing 51% or 26% FDI (which have been the proposed figures till date) will have immediate and dire consequences. Entry of foreign players now will most definitely disrupt the current balance of the economy; will render millions of small retailers jobless by closing the small slit of opportunity available to them.

Wal-Mart, the world’s biggest retailer sets up operations in India at prime locations in the 35 large cities and towns that house more than 1million people13. The supermarket will typically sell everything, from vegetables to the latest electronic gadgets, at extremely low prices that will most likely undercut those in nearby local stores selling similar goods. Wal- Mart would be more likely to source its raw materials from abroad, and procure goods like vegetables and fruits directly from farmers at preordained quantities and specifications. This means a foreign company will buy big from India and abroad and be able to sell low – severely undercutting the small retailers.

1.1.2 The Growth Momentum

The AT Kearney’s 2004 Global Retail Development Index ranks India as the second most attractive retail destination among the 30 odd emerging markets and places it next to Russia pushing China to 3rd position. Gradual opening up of the retail segment for FDI will work to the advantage to both the consumers and existing retailers. While consumer will have variety of global standard branded goods and services to choose from and that too at reachable cost. The existing retailers will be saddled with a host of unseen opportunities like joint ventures with foreign partners apart from avenues to upgrade their technologies, systems etc. More importantly FDI in retail in India would help generating millions of jobs for the teeming jobless numbers in India.

A conservative estimate puts the number of direct jobs at one million in three years. More importantly revitalized retailing necessitating a never ending supply chain of goods and services will infuse new life into the manufacturing sector, especially agriculture, food processing, small and medium enterprises and handicrafts creating avenues of indirect employment for many more millions. At the macro level, FDI in retail will enable Indian economy to integrate with the global economy. It will help to overcome both the lack of experience in organized retailing as well as lack of trained manpower.

FDI in retail would reduce cost of intermediation and entail setting up of integrated supply chains that would minimize wastage, give producers a better price and benefit both producers and consumers. From the stand point of consumers, organized retailing would help reduce the problem of adulteration, short weighing and substandard goods. FDI in retail sector would certainly enable to optimize youth employment in India. For those fearing the effects of FDI in retail in India, the examples of Thailand and China should give comfort. Entry of foreign players in Thailand and China gave a big boost to retail and the exports in both countries got a shot in the arm. Notwithstanding the mounting pressure from left wing parties, the present Indian government has decided to allow FDI in retail outlets meant exclusively for single brands which mean that multinationals can invest upto 51% in joint ventures for marketing their premier brands. However, the policy certainly needs a relook and should evaluate measures for further liberalization to invite FDI in this sector to optimize youth employment opportunities.

1.1.3 Organized Retail in India

Organized retail in India is on a high growth trajectory and is expected to grow by around 27 per cent per annum in the next 5-6 years. The total organized market size, estimated at around Rs 530 billion in 2005-06, will increase to around Rs 1,797 billion by 2011. The sector is witnessing an influx of large domestic and international conglomerates as they want to tap the retail opportunity and capture the large market share. In addition, large investment announcements have been made both in the front as well as back-end operations of the industry.

Rising disposable incomes, demographic changes, change in the perception of branded products, growing number of retail malls and availability of cheap finance will provide a fillip to the industry. However, regulatory impediments, unavailability of low-priced real estate, inadequate infrastructure facilities and lack of trained manpower could hinder this growth. The retail industry is divided into organized and unorganized sectors. Organized retailing refers to trading activities undertaken by licensed retailers, that is, those who are registered for sales tax, income tax, etc. These include the corporate-backed hypermarkets and retail chains, and also the privately owned large retail businesses.

Unorganized retailing, on the other hand, refers to the traditional formats of low-cost retailing, for example, the local kirana shops, owner manned general stores, paan/beedi shops, convenience stores, hand cart and pavement vendors. Unorganized retailing is by far the prevalent form of trade in India – constituting 98% of total trade, while organized trade accounts only for the remaining 2%. Estimates vary widely about the true size of the retail business in India.

Food retail trade is a very large segment of the total economic activity of our country and due to its vast employment potential; it deserves very special focused attention. Efficiency enhancements and increase in the food retail sales activity would have a cascading effect on employment and economic activity in the rural areas for the marginalized workers. Thus even without FDI driving it, the corporate owned sector is expanding at a furious rate. The question then that arises is that since there is obviously no dearth of indigenous capital, what is the need for FDI? It is not that retailing in India is in the need of any technology special to foreign chains.

Organized retail comprises various categories, of which food and grocery is the biggest category accounting for around 74 per cent of total retail. However, it has the lowest organized retail penetration of around 1 per cent. Footwear, consumer durables and clothing are segments with highest organized retail penetration. Food and grocery, and home décor segments are expected to rapidly grow in the coming years.

1.1.4 Organized retail will grow in top 25 cities

In the near future, the organised retail activity will be restricted to urban India. The analysis by CRISIL Research shows that around 87 per cent of this retail opportunity comes from the top 25 cities in India. With a growth in GDP under the business as usual scenario, the total retail opportunity in the top 25 cities will grow from Rs 2.2 trillion in 2006 to Rs 3.4 trillion in 2011.

1.1.4 Definition

Foreign Direct Investment (FDI, hereafter) refers to an “investment made to acquire lasting interest in an enterprise operating outside the economy of the investor with the basic purpose being to gain an effective voice in the management of the enterprise” (UNCTAD, 1993).

The IMF defines foreign investment as direct when the investor holds 10 percent or more of the equity of an enterprise and covers claims that are intended to remain outstanding for more than one year. The five main forms of FDI identified are

Greenfield investment (a new operation)

Brownfield investment ( expansion or re-investment in existing foreign affiliates)

Mergers & Acquisitions

Privatization & Equity investment

New forms of investment (Joint ventures, strategic alliances, licensing and other partnership agreements)

Greenfield investments are the primary target of a host nation’s promotional efforts because they create new production capacity and jobs, transfer technology and knowhow, and can lead to linkages to the global marketplace. FDI can also be considered as a source of economic development, modernization, and employment generation, whereby the overall benefits (dependant on the policies of the host government) “triggers technology spillovers, assists human capital formation, contributes to international trade integration and particularly exports, helps create a more competitive business environment, enhances enterprise development, increases total factor productivity and, more generally, improves the efficiency of resource use” (OECD, 2002).

It is said to be “usually preferred over other forms of external finance because they are non-debt creating, non-volatile and their returns depend on the performance of the projects financed by the investors. FDI also facilitates international trade and transfer of knowledge, skills and technology.”(GOI, 2002).

UNCTAD regards FDI as a vital factor in the long-run economic development of the world’s developing countries. According to Pradhan (2000, p.26), host countries and MNCs are mutually interested in FDI. It is not a zero sum game but a “win-win deal”. FDI can indeed enable foreign firms to exploit market opportunities and help host countries respond to a lack of adequate capital, production facilities and technology.

Attracting investments for growth, particularly FDI is currently one of the top priorities of many developing countries, because FDI can be the driver of successful transitions through the transfer of private capital, technology and personnel (Makola, 2003).

Owing to the important role that FDI plays; it is one of the most fascinating and intriguing topics among researchers in the field of international business. The literature on FDI identifies a bi-directional relationship between FDI and growth and this relation is heterogeneous across various countries. (Chowdhury and Mavrotas, p.18, 2006). The way a country is influenced by the inflow of foreign capital has important policy implications and is crucial for identifying the course of future development.

AIMS AND OBJECTIVES OF THE REPORT

The aim of this research was to examine and evaluate the long term impact of allowing FDI in the Indian Retail Sector.

Following were objectives of this research:

Analyze the current retail scenario in India with prime focus on the growth of organized retail segment

Evaluate and bifurcate the positive and negative impact of allowing FDI in organized retailing in areas like investment, technology & supply chain, employment, consumers, farmers, manufactures & suppliers, domestic retailers & productivity and operational efficiency of the domestic retail sector.

Examine the various factors which will determine the flow of FDI in Indian Retail Sector

Examine and evaluate the various challenges faced by the Indian Retail Sector which may act as potential roadblocks to foreign investments in the sector

Recommend measures that government should employ to enhance the competitiveness and market attractiveness of the Indian Retail Sector

1.3. STRUCTURE OF THE STUDY

The Dissertation paper has been divided into five chapters which are Introduction, Literature Review, Research Methodology, Findings & Analysis and Conclusion & Recommendations.

Chapter One presents an introductory outline of the whole dissertation paper which is based on the topic of Foreign Direct Investment in Indian Retail Sector. Chapter Two seeks to review the literature on foreign direct investments- the rationale and determinants for undertaking such investments & the impact that foreign capital inflows have on the host country. It also traces in brief the evolution of India Retail Sector from a highly regulated to a more open industry and the various factors that deter and attract investment in the sector. Chapter Three details out the research methodology applied in the dissertation In Chapter Four, the various findings of the research are analyzed and reasoned. Finally Chapter Five concludes the research with a summary of the results and the various policy measures that the government & domestic organized players should employ to enhance the attractiveness of India as a global retail destination.


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