FDI in Retail in India By; Dr.

Neelam Tandon PGDM II A, B and IB

The matter of FDI (foreign direct investment) in retail is best understood in terms of economics, although the FDI policy is a matter of politics. When one is talking about anything that has to do with economics, it is helpful to use a bit of common sense and to stick to the basics, as we will now proceed to do. FDI in multi-brand retail is being opposed by some, including the BJP. The question of whether FDI in retail is good or not is being hotly debated. To the extent that the debate is related to the economics of organised retail and foreign investment in it, the debate is pointless because it takes only a few minutes to get to the heart of the matter. Consider these fun facts.

Retailing is an essential service in any large modern economy (or any economy that has hopes of being modern). Organised retail is a necessity only for developed economies because it is the bridge between the production of a large number of goods and a large number of people with specific preferences and varied choices. For poor underdeveloped economies, informal retail suffices given that very few goods are produced and people have little choice.

Organised retail is a good thing in any sufficiently large economy. It increases distribution efficiency, and increases production through increased efficiency in resource allocation. In the absence of organised retail, a good deal of labour is involved in low productivity retailing of small amounts of goods.

Organised retail requires investment, in terms of capital and human resources. This is an obvious fact but is often overlooked. Even if desired, organised retail will not happen if required human resources are missing.

Foreign investment augments domestic investments and is good for the economy. If domestic investable resources fall short of whats necessary, it is a good idea to attract foreign investment. One large poor economy (which we need not name) did very well over the last few decades by attracting hundreds of billions of dollars in foreign investment.

India needs an efficient retail sector again an obvious fact that is overlooked by some, perhaps because it is not in their interest to recognise this fact. Indias domestic resources are insufficient for creating an efficient retail sector. Therefore inflow of foreign investments in retail is good for India. But what about the millions of small kirana store keepers? Some of those stores will no longer be viable. Some not all. Some of the people currently in the unorganised retail sector will find employment in the organised retail sector. Consequently, fewer people will be needed for the same volume of retail which is another way of saying that there will be labour efficiency gains. Increased efficiency also means higher wages in the retail sector. That is good news. But wait, theres more. A growing economy implies that the retail sector will also grow. With sufficient growth in the economy which follows naturally under easily obtainable conditions employment in retailing will grow even with increased efficiency in retail. It is a mistake to consider the economy a static game. Economies are dynamic structures and it is possible to have changes that benefit some without hurting others. In other words, Pareto improvements are possible. (A Pareto improvement is one by which at least someone becomes better off without making anyone else worse off.) An example of the dynamic nature of the economy is the telecom sector. At one time, it was feared by some that increasing the efficiency of the sector will lead to unemployment among the telecom labour force. As it turned out, those fears were unfounded since the growth in the economy, and therefore growth of the sector, saw an increase in employment together with higher wages. Not just that, it also led to cost decreases which are reflected in the low prices of telecom services we all enjoy. The cost of retail is a wedge between the consumer and producer prices. Reducing the size of the wedge is good for everyone with the possible exception of those who gain from the inefficiencies of the current system. The losers will have to find alternative ways of making a living. But that is another story. Foreign Exchange Volatility in India The rupee has lost almost a fourth of its value against the dollar in last one year. This fall has created a chorus of demands from industry as well as sections of the political establishment

that the Reserve Bank of India (RBI) should step in and use its foreign exchange reserves to stabilise the value of the rupee. The RBI, on the other hand, has been categorical that it will only step in to curtail the volatility and not to support the value of rupee at some pre-determined price. Two things seem self-evident. First, a lot of the people who are asking the RBI to step in are either unaware of or ignoring the economic forces behind the fall of the rupee. The second is that the RBI, for good reason, has been less interventionist than expected. The fact is that the increased volatility in the rupee is result of the global integration of our economy. In a way, it stands testimony to how far we have come from 1991. Globalisation has got us easier access to capital flows that fund our current account deficit - especially our imports of oil and gold. But it is these capital flows that are causing the volatility in the rupee. But before we get into that, let us just step back and look at causes of the problem. The fact is that we have a negative trade deficit - on top of that, our imports are growing faster than our exports. Oil prices and gold prices affect our import numbers considerably. Most of our imports and exports are price inelastic. Due to fuel subsidy, oil price increases do not result in lower consumption. Also, due to inflation and lack of a developed financial sector, households use gold buying as a savings tool. Theoretically, a depreciating rupee should make our exports competitive. But given the economic turmoil in our major markets like US, our exports - IT is a great example - have been impacted and a lower price of the rupee will only help these exports to a limited extent. Given this, the current account deficit is here to stay. It may fluctuate 2-4% of GDP. At 2%, we are comfortable, and at 4%, the rupee is under pressure. The 2% current account deficit is manageable due to FDI and other capital flows that are stable. The gap between 2% and 4% is made up by portfolio flows that, by their very nature, are volatile and skittish. They react constantly to changing perceptions about the global and India economies. They will aggressively pursue predictable growth, yet would flee an emerging market because of local or global uncertainty.

So if the rupee value is going to be primarily dependent on capital flows, then volatility is a given. There is a chorus for the government and RBI to take policy decisions, but what needs to be understood is that policy decisions taken locally or globally will also increase volatility; albeit in the opposite direction. For example, any global liquidity easing will increase risk taking and capital will flow to emerging markets, including India. This short-term flow, while easing the downward pressure on the rupee, will lead to enhanced volatility.

US Fiscal Cliff and Its impact on Indian Economy The unfolding fiscal cliff in the United States is going to be as dramatic as the Barack Obama-Mitt Romney election was and it will hit the American and global economy with all the force of a financial Hurricane Sandy. The term fiscal cliff has been coined to describe several big fiscal events set to occur in the U.S. at the end of this year and in early 2013. Among them: The expiration of the Bush-era tax cuts at the end of 2012, including current lower tax rates on capital gains, dividends, income, and estates, as well as number of other measures. The expiration of fiscal stimulus measures, such as the payroll tax cut and extended unemployment benefits. Spending cuts scheduled to be triggered automatically in January 2013 as a result of the failure of the deficit reduction super committee last year. Without a broad consensus among Republican and Democrat lawmakers to ensure the required Congressional action before the end of this December, up to $600 billion of expiring tax cuts, the levy of new taxes and automatic spending cuts are set to take effect at the beginning of 2013. If they hit all at once, the impact could be as much as a four to six per cent decline in the GDP of the U.S., according to some researchers the equivalent of falling off a fiscal cliff.

In the less likely scenario that Congress and the White House fail to reach any compromise whatsoever and are unable even to agree on how to delay the looming measures, there would be major consequences for global financial markets. At present, the U.S. economy is growing roughly at two per cent per annum. A four to six per cent contraction in GDP caused by the fiscal cliff would push the worlds largest economy into a recession. Coupled with the sagging European economies and a slowdown in Chinas growth, a recession in U.S. could be really bad for the world. S&P 500 and Dow Jones are now trading nearer to their all-time highs. Hence it would not be too surprising if U.S. stock markets fall in the possibility of a fiscal cliff. According to a recent Bank of America Merrill Lynch fund manager survey, nearly three-quarters (72 per cent) of global investors believe that the fiscal cliff is not substantially priced into global equities and macroeconomic data. The fiscal cliff is identified as the number one tail risk by 42 per cent of respondents up from 35 per cent in September and 26 per cent in August. However, some people regard Emerging Market (EM) equities as safe haven assets. There may be that perception. But if you look at the correlation of returns of EM equities, they are positively correlated to global equities. Hence any fall in global equity markets due to a fiscal cliff could cause a fall in all emerging stock markets including India. A fiscal cliff in the U.S. could also lead to a reversal of capital flows to emerging markets. At the recent International Monetary Fund meet in Tokyo, Finance Minister P. Chidambaram said that the issues of fiscal cliff and the lifting of the debt ceiling in the U.S. also need to be resolved. The need is to put in place a medium-term fiscal plan while avoiding excessive fiscal correction in the short run. Should the economic situation in the U.S. worsen, its impact on emerging market economies will be much more severe than in the case of the situation in the euro area.Markets have been working on the assumption that the U.S. is going to address the fiscal cliff challenge with a more gradual adjustment.