Coming To Market

The Economist

Special Report

Retailing in India

Apr 12th 2006 DELHI

The final frontier for global retailing is beginning to open

“WHY are Indians better at cricket than at soccer?” asks Dilip Modi, boss of Spice Communications, an Indian mobile-telephony firm. Because, he jokes, every time you award an Indian a corner, he opens a shop. India, according to a study published last year*, has the highest density of retail outlets of any country in the world—more than 15m, compared with 900,000 in America, where the market is, in value terms, 13 times bigger. In India the retail industry is the largest provider of jobs after agriculture, accounting for 6-7% of employment and about 10% of GDP.

It is also protected from foreign competition by rules that, despite some recent relaxation, still bar foreign direct investment (FDI) from most of the industry. But foreign firms, such as Wal-Mart, the world's biggest retailer, and its British and French rivals, Tesco and Carrefour, like the look of India's booming economy and its fast-growing middle class, and are knocking at the door. There are plenty of voices in India arguing it should be kept shut, lest an influx of foreign supermarket chains close millions of small shops. But the government, a coalition led by the Congress Party, is committed to the 15-year-old process of deregulating and opening up the Indian economy. The issue of whether or not to allow FDI in the retailing industry has become one of the touchstones of Congress's ability to make difficult reforms in the teeth of opposition, especially from the Communist parties on whose votes it relies for its parliamentary majority.

The debate about FDI, however, is really only one part of a broader argument. Kamal Nath, the minister of commerce, describes it succinctly: “big versus small”. A whole range of constraints—legal, infrastructural, cultural and even educational—have inhibited the growth in India of large-scale organised retailing. But a number of companies are now taking up the challenge. In doing so, they are building a new protectionist lobby against FDI. But they are also strengthening the arguments in its favour, from those fearful of the emergence of a domestic cartel.

Only 4% of India's shops occupy a space of more than 500 square feet (46 square metres). Even in Delhi, some upmarket shopping centres, such as Khan Market, are clusters of tiny shops. In grocery shops boys perch precariously on ladders to fetch jars from remote crannies. In the bookshops browsers brush bottoms as they squeeze past each other in crowded aisles. Some of the poshest clothes shops are reached up narrow, twisting staircases.

Most Indian shops belong to what is known, quite accurately, as the “unorganised” sector—small, family-owned shops surviving on unpaid labour and, often, free land for a small stall. “Organised” retailing accounts for only 2-3% of the total, and of that, 96% is in the ten biggest cities, and 86% in the biggest six. However, organised retailing is growing at 18-20% a year and inspiring a rush of property development. Shopping malls are springing up in every big town: some 450 are at various stages of development.

Already, some retail chains have a national reach. Pantaloon, for example, which started business in 1987 as “India's first formal trouser brand”, employs 12,000 people in more than 100 Pantaloon and other shops, “Big Bazaar” hypermarkets and “Food Bazaar” supermarkets. Kishore Biyani, its boss, believes he is in “the right business in the right country in the right time”. The firm plans to expand its 3m square feet of shops to 10m square feet by the end of next year. Its website boasts it will become a “Godzilla” of Indian retailing.

Another monster, however, is stirring. Reliance Industries, an oil, petrochemicals and textiles giant, and India's largest private-sector firm, has startlingly huge retail plans. So big, in fact, that Mr Biyani believes they are not physically possible. Insiders say they involve 100 billion rupees ($2.2 billion) of investment in 1,500-1,800 supermarkets and hypermarkets, employing 400,000-500,000 people, with 60 supply centres, some with their own airstrips, strategically located round the country, all in the next two years. The wares will range from food to clothes to electronics. That is just for starters: in private, the firm talks of 1,000 hypermarkets and 2,000 supermarkets within four years.

Reliance spokesmen admit to no qualms about the scale of this undertaking. Yet the obstacles that any organised retailer faces are immense. As Mr Biyani puts it, “we are used to working under ‘other things not being equal’”. Should the doors ever open fully to foreign competitors, that experience will be a consoling competitive advantage. Among the problems are:

•Potholes India's electricity supply, roads and ports are all in sore need of investment. This is one of the biggest obstacles to the growth of organised retailing—but also one of the strongest reasons for encouraging it. The government simply does not have the resources to produce the investment India's woeful infrastructure needs, and is hoping for a bigger contribution from private-sector firms. Transport delays and inadequate cold storage mean that between 35% and 40% of fruit and vegetables grown in India rots where it is harvested or in transit.

•Land grabs Businesses and building projects of all sorts are often hobbled by the difficulty of getting land. In many places in India land titles are obscure and disputed, and land use is subject to restrictive limitations. The risks have been highlighted in Delhi, where in February the Supreme Court told the government to take action against illegal building and the misuse of residential property. It has done so by demolishing shops, including even some in swish malls, and by “sealing” hundreds of others. By one estimate 500,000 shops in the capital operate from “residential” premises.

However, Arvind Singhal, of Technopak, a consultancy, says that outside a handful of big cities such as Delhi, Mumbai and Bangalore, it is not too hard to buy land without prohibitive expense. In “second-tier” cities, such as Chandigarh and Jaipur, two state capitals in northern India, it is possible to find land in the centre of town. In smaller towns it is feasible to build hypermarkets on the periphery. Reliance, for example, says it has already bought 30% of the land it will need for its first distribution centres, and sees no problem in finding floor space for its shops, because of the mall-building boom.

•Red tape Organised retailers also have to negotiate a bewildering minefield of central, state and local government rules and regulations at every stage of their operations. In most states the Agricultural Produce Marketing Committee Act, for example, prevents farmers from selling their wares directly to retailers. In Karnataka, in the south, most farm produce must be bought and sold at the government-run market. So at a vast cash-and-carry centre in Bangalore, the state capital, opened by Metro, a German group, the acres of shelf-space designed for fruit and vegetables are empty or otherwise occupied. In many states, land-ceiling legislation prevents large-scale contract farming. Some sorts of food processing are “reserved” for small businesses. In towns the size of shops and permissible opening hours are governed by local rules.

Labour laws discourage large businesses by making it hard for them to lay off staff. Retailers also need to collect sheaves of licences, covering general trading, specific products, pollution clearances and so on. According to a 2003 study, a new shop needed, on average, 15 licences from 11 government bodies, and securing them took an average of six months and cost up to 500,000 rupees. Pantaloon's Mr Biyani says that every time a regulation disappears, a new one takes its place. He identifies the Environment Ministry as the biggest logjam. One of his planned developments has been stalled for a year. He is also exercised by a law in the state of Maharashtra (which includes Mumbai) banning plastic bags. “No retailer in the world,” he laments, “can understand this.”

Organised retailers have to cope with a tax system of bewildering complexity and cascading cost. A transition to a nationwide state-level value-added tax (VAT), and a national goods-and-services tax is underway. The present system involves import- and excise-duties, state-level and central sales taxes, VAT, octroi (a tax on goods in transit) and turnover tax.

•People problems Sanjeev Duggal, of NIS Sparta, a training and consulting firm, diagnoses an unlikely “Achilles heel” for big retailers in India: people. Despite the huge numbers employed in the retailing sector, it is not, he says, a “preferred career”. Even Reliance, he believes, will struggle to find enough people with enough education to become good staff. Beth Keck, of Wal-Mart, argues that good, clean working conditions can make the profession more attractive. Reliance officials say it is becoming a top career choice for business graduates.

Conversely, some of those who are opposed to organised and foreign retailing argue both that it will put small shopkeepers out of work, and that it will not offer jobs for those with only a basic education. Pantaloon's Mr Biyani, however, who is recruiting 500-600 people every month, says that only about one-third of them have a college education.

Glittering prize

If the difficulties facing organised retailers in India are huge, then the possible rewards must be even huger to have attracted such intense domestic and foreign interest. This is part of India's broader surge of economic self-confidence at home, boosted by a spell in the international spotlight. The country is engaged in a prolonged coming-out party, where the world is at last noticing its size, achievements and potential.

The economy is one of the world's fastest growing, with GDP expanding at an average annual rate of about 7.5% for the past three years. A young population, declining dependency ratio and higher savings rate lead even the most sober economic forecasters to expect the growth rate to average 6% or so for the next few decades. The more sanguine think 8% can be sustained and even bettered.

Moreover, from the point of view of the retail trade, India's growth has an especially attractive feature: much of it comes from a surge in private spending. As Stephen Roach, an economist at Morgan Stanley, has pointed out, private consumption accounts for a big chunk of the Indian economy: 64%. That is more than in Europe (58%), Japan (55%) and, especially, China (42%). India's transition to a high-growth path, argues Mr Roach, “is very much an outgrowth of the emerging consumerism of one of the world's youngest populations.”

India is still, of course, a poor country. Only one in 50 households has a credit card; only one in six a fridge. As in China some 15 years ago, such measures are taken not as a deterrent, but as an indicator of the enormous potential size of the market. As an estimate of the size of the Indian middle class, the figure of 300m, used by an awe-struck George Bush on his visit here last month, has taken hold. But that would include all households with an income exceeding $2,000 a year in 2001-02 prices. A narrower definition used by the National Council of Applied Economic Research, a Delhi think-tank, puts the bar at about $4,400, leaving a consuming class of just 58m.

Since households have an average of 5.4 members, the figure of 58m is probably nearer the mark as a gauge of those with genuine discretionary spending power. But even so, the retail market is big and growing fast. Technopak, which estimated its total size at about $200 billion in 2004, expects it to reach $275 billion by 2010, with the share taken by organised retailing increasing to 9%, or $23 billion, implying an annual growth rate of 25-30%.

Queuing up to check it out

That is certainly big enough to attract foreign interest. Wal-Mart, in particular, has been eyeing the market keenly. The American company's prominent involvement in the campaign for an opening-up of Indian retailing may not be helpful: for some, it is the sort of company that stands for everything the Indian left seeks to oppose. H. Mahadevan, for example, of the All-India Trade Union Congress, calls it “one of the ten worst corporations in the world”, and opposes foreign investment in retail on the ground that “the Western concept of maximising output and minimising labour does not suit India”.

Yet those in favour of FDI argue that investment would generate employment. Ajay Dua, a senior civil servant in the Ministry of Commerce and Industry, says that every direct retail job brings another at “the back end”. In addition are the jobs that would be created among suppliers in industries such as food processing. According to the ministry, food processing in India adds just 7% to the value of agricultural output, compared with more than 40% in China and 60% in Thailand. This is one area Manmohan Singh, the prime minister, singles out as promising large numbers of jobs, but where “we have barely scratched the surface”. Some 100m Indians will join the workforce in the next decade, and there is great concern that, despite high growth rates, employment has remained flat, partly because of the failure of labour-intensive industries such as food processing to take off.

Easily brushed aside?Mr Dua says he has a fat report on his desk from Wal-Mart, describing, among other things, how it runs three-month training courses in some places for those who find themselves displaced and jobless by the firm's arrival. But he points to the experience of Thailand, which opened up to foreign retailers after the Asian crisis in 1997. In the short term, according to the report cited earlier, “the entry of foreign players in a recessionary economy adversely affected all segments—wholesalers, manufacturers and domestic retailers.” However, there were also benefits. The foreign invasion led to the development of organised retailing (now 20% of the Thai market); producers had to become more efficient; foreign retailers started buying more Thai goods.

Wal-Mart argues the same would happen in India. At present it has 120 people in Bangalore, buying about ten categories of Indian products for its shops (clothing, textiles, shoes, leather wallets, stationery and so on). Were it to have outlets in India, its procurement would naturally increase. (The Metro operation in Bangalore buys 98% of its stock locally.) Suppliers would become familiar with its requirements, and exports would also climb. In China Wal-Mart accounts for nearly 10% of all exports to America.

Wal-Mart's Ms Keck is unapologetic about the firm's high profile in the campaign to open up India's market, arguing that it could hardly keep its ambitions secret. There has been progress. In January, just before the World Economic Forum in Davos, where India mounted a public-relations blitz, the government relaxed the rules on FDI. Foreign firms would be allowed to hold up to 51% in “single-brand” retail outlets, such as shops selling Nokia handsets or Nike shoes. At Davos Mr Nath said that “multi-product” single brands—a supermarket's own branded goods, say—would also be allowed to invest. The government also made it easier for foreign wholesalers to invest in “cash-and-carry” operations, such as Metro's.

Wal-Mart greets the “single-brand” decision as a great step forward. Those claiming inside knowledge suggest the provisions will be applied leniently, and that this amounts to a big liberalisation by stealth. The foreign firms will come in without a big political confrontation. Technopak' s Mr Singhal, however, thinks the single-brand exemption is a pointless cosmetic move. Speciality brands are anyway more likely to sell through franchises than joint ventures, and especially if they are forced by the rules to have a local partner.

Many, however, think the government will be forced to open up when, in Mr Singhal's words, “the real juggernaut starts rolling out”. Without referring to Reliance, Mr Dua of the Ministry of Commerce seems to agree: “if you are going to have organised retailing, let there be competition.” Reliance is confident it can compete even without a ban on FDI—and it will have a head start anyway. Pantaloon's Mr Biyani, however, is arguing against allowing the foreigners in. “What's the hurry?” he asks. If rules were relaxed now, he claims, India would attract no more than $2 billion-3 billion in FDI in retailing. If it waits a few years, he argues, that could increase to $15 billion-20 billion.

Whenever they are allowed in, the foreign shops still need to think hard about how to appeal to Indians. Shoes offer an example. Harsh Bahadur, boss of Metro in Bangalore, recounts how he realised that most makes were inappropriate for his customers—service businesses whose staff were swapping sandals for shoes and socks for the first time. Traditional, pointy-toed, lace-ups were too cramped for feet that have lived life in the open. So he commissioned a new range of square-toed footwear.

Mr Singhal says most foreign chains are still approaching India in a “classical” way: “Let Indians change.” Indians will, he concludes, and “maybe in 20 years' time, all India will go to a hypermarket.” Before then, however, a woman will prefer to buy her salwar or saree in the cramped little shop she has always used, rather than stroll down a fluorescent-lit aisle piling up a trolley with off-the-peg fashion.

* “FDI in retail sector: India” Arpita Mukherjee and Nitisha Patel, Department of Consumer Affairs, India, and Indian Council for Research on International Economic Relations.