In a bid to further liberalize the existing foreign direct investment ("FDI") regime in India, on August 28, 2019, the union cabinet approved several amendments to the existing FDI policy of the country (the "Extant FDI Policy").
This move comes amidst increasing concerns of an impending global economic slump and declining market confidence in India, and is the latest amongst a series of steps taken by the central government towards making India a more attractive foreign investment destination.
Perhaps the most significant amendments to the Extant FDI Policy pertain to foreign investment in single brand retail trading ("SBRT"). SBRT in India has seen rapidly growing foreign interest over the past few years, with the SBRT sector having received total foreign investment of approximately USD 1,636.24 million in the period between April, 2006, and April, 2019. The present amendment is preceded by, and is aligned with, the recent liberalization of SBRT FDI norms, as announced on January 23, 2018 (the "2018 Amendment"). The 2018 Amendment scrapped the requirement for government approval for investment over 49% in SBRT Entities and permitted 100% FDI under the automatic route in SBRT Entities.
The newly announced amendments to the Extant FDI Policy include the easing of local sourcing norms for SBRT and granting of permission to entities undertaking SBRT (each, a "SBRT Entity") to conduct retail trading through e-commerce, prior to establishment of brick and mortar stores.
While the corresponding amendments to the Extant FDI Policy and the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (the "FDI Regulations") are still awaited, a detailed analysis of the amendments to the Extant FDI Policy applicable to the SBRT sector, as announced by the Government of India on August 28, 2019 is set out below.
A. Easing of Local Sourcing Norms. Under the Extant FDI Policy, SBRT Entities with FDI of over 51%, are required to source 30% of the value of goods purchased by them from India, and that too, preferably from MSMEs, village and cottage industries, artisans and craftsmen (the "Local Sourcing Requirement"). Further, the Local Sourcing Requirement has to be met by the SBRT Entity: (i) during the initial 5 (five) years of the SBRT Entities' operations (beginning April 1st of the year in which business commences, i.e., its first store opens), as an average of the total value of the goods purchased during this period; and (ii) thereafter, on an annual basis. Additionally, during the initial 5 (five) years of the SBRT Entities' operations, 'incremental sourcing' of goods from India for global operations of the SBRT Entity is counted towards the Local Sourcing Requirement.
In this regard, the following amendments have been approved:
(i) All procurements made from India by the SBRT Entity for its single brand, at any time, will now be counted towards the Local Sourcing Requirement, irrespective of whether the goods procured are sold in India or exported. This is a change from the Extant FDI Policy, under which, after completion of the initial 5 (five) years of the SBRT Entities' operations, the Local Sourcing Requirement is not permitted to be met through exports.
(ii) The entire sourcing from India for global operations of the SBRT Entity, and not just the 'incremental sourcing' (i.e., the value of such sourcing in a financial year which is over and above that of the preceding financial year) for global operations, will now be considered towards fulfilling the Local Sourcing Requirement. The Extant FDI Policy provides that only 'incremental sourcing' of goods from India for global operations of a SBRT Entity, and not the entire sourcing, will be counted towards the Local Sourcing Requirement.
(iii) Procurement of goods from India for global operations may now be done by a SBRT Entity through a third-party, under a legally tenable agreement. As per the Extant FDI Policy, procurement for global operations may only be undertaken by a SBRT Entity either directly, or through its group companies. This amendment is in line with existing business practice, since prevalent business models involve not only sourcing by SBRT Entities and their group companies, but also sourcing through unrelated third-parties.
B. Permitting e-commerce without brick and mortar stores. Retail trading of its brand through e-commerce may now be undertaken by a SBRT Entity, even before such SBRT Entity opens a brick and mortar store. However, this permission is subject to the condition that such SBRT Entity opens a brick and mortar store within 2 (two) years from the start of such electronic retail. The Extant FDI Policy requires that SBRT Entities operate through brick and mortar stores prior to starting retail trading of their brand through e-commerce.
Given that the Local Sourcing Requirements applicable to SBRT Entities have historically been a significant impediment in securing foreign investment in the SBRT sector, the relaxation of the Local Sourcing Requirements is a significant move, which may prove to be a game-changer for easing operations of SBRT Entities and for attracting increased foreign investment in this sector.
The move has already been hailed as a welcome policy decision by global retail giants like IKEA and H&M. Additionally, the relaxation from Local Sourcing Requirements is also welcome news to tech giants like Apple, Xiaomi and LeEco, that have previously sought, but failed to receive, exemption from these requirements. In fact, following the announcement of the new government policy, Apple has also reportedly praised the new government policy, and has indicated that the company is looking at setting up India's first Apple retail store soon. The entry of a greater number of multinational retailers into the Indian markets will serve to benefit Indian consumers by allowing them access to a larger variety of purchasing options and by increasing market competitiveness. Additionally, Indian manufacturers will also have to raise product quality and compete on price points with such foreign players or risk losing market share to them.
Moreover, removal of the restriction on undertaking electronic trading by a SBRT Entity without establishing brick and mortar stores can be expected to boost e-commerce activity in the country, and will allow Indian customers to access goods of international SBRT Entities, before such retailers actually establish their physical stores in the country. Increased e-commerce activity will also directly result in a larger number of digital payments and higher tax revenues for the government.
Further, while Local Sourcing Requirements have been relaxed and made less onerous for retailers, the government has chosen not to completely do away with these requirements. This policy decision to preserve Indian manufacturing interests comes at a time when several multinationals are looking to move their manufacturing processes out of China, to avoid a swiftly escalating US-China trade war.
It is also worth noting that, while the newly announced amendments to the Extant FDI Policy seem, on the whole, to be positive for foreign investment in SBRT in India, additional conditionalities in relation to the approved amendments may be forthcoming in the corresponding amendments to the Extant FDI Policy and the FDI Regulations. As such, the impact of such conditionalities on the sector may need to be further evaluated.