Economics, like many other field, is a subjective science. It is open to speculations and interpretation based on a particular view point held by an economist. Two contrasting view points could co-exist, with sufficient evidences and research works to support both the view points. The recent debate on Foreign Direct Investment (FDI) in Retail Sector in India is another case in point. There are economist and politician alike who hold contrasting view points about the subject both giving arguments backed with research data that proves their respective views.

I wanted to take this opportunity to try and put forward my view point about the subject as per my understanding and interpretation of the matter. I have no political leanings towards any parties and nor am I a capitalist or a communist or a Keynesian economist to be influenced by any one particular form of thought. I just present some plain calculation as per my understanding of the subject and whatever little I managed to gather through my limited reading.

Before we come to the point of whether FDI is beneficial or harmful, we need to understand few factors and involve few variables to understand the effect. First is the Exchange Rate [value of local currency against $], second is inflation [purchasing power of money], third is trade deficit [Exports minus the imports] and fourth is liquidity [amount of money in circulation]. All of these factors are tightly tied together in a cause-effect or effect-cause relationship. It is a general practice that international trade is measured against the $ and so is the exchange rate of a local currency.

Let us observe the macroeconomic condition of the Indian Economy against the above factors.

Exchange Rate: The Rupee has significantly depreciated against the Dollar over the past year and is at the moment the worst performing Asian currency vis-a-vis $. This situation, does benefit the exporters as they earn more for the same quantity of goods exported but, it hurts the importers, as the commodities in the international market become dearer. The reason for the Rupee nosedive is because of reverse flow of $ out of the country. Lack of $ supply and increasing demand for $ has made it dearer resulting in a depreciating rupee. Some of the reason for the reverse flow of $ are:

– FII (Foreign Institutional Investors) pulling back $ from the Indian market due to macroeconomic conditions in their country of origin [European or US crisis]
– Increasing cost of Crude Oil
– High demand for Gold in India – means purchasing gold from international market at the expense of spending $

Each of the above has led to reverse flow of $ thus making Rupee nosedive to it’s lowest value ever. Though this has a silver lining but I would come to that towards the end of the post.

Inflation: For the last year or so the inflation levels have been uncomfortably high and the rupee nose dive has definitely contributed to the higher commodity prices in the local market. India also has had a chronic problem of negative Trade Deficit , which means it Imports more than Exports which would always effect the ForEx Reserves of the country as we would spend more $ than what we earn. It also means that, with a depreciated Rupee every import is expensive and the product continues to be in the local market. If the price of the import goes up in international market  (like crude oil) then those imports become even more dearer in the local market. Pushing inflation higher. This has led to lesser confidence of FII or FDIs thus prompting them to pull back the $ from Indian Market

Liquidity: Liquidity indicates, the amount of money in circulation in the market available for commercial transaction. Central Bank [Reserve Bank of India] is the sole controller of this Monetary Policy. It is common sense that higher liquidity equates to higher commercial transaction, however a stubborn inflation level with the existing circulating money has tied down the hands of the central bank from increasing any more amount of money in circulation through the instruments available with them. With less money in the market, banks charge a higher interest rate on loans, which has repercussion on every other aspect of the economy as people borrow less and invest less. The reduced economic activity due to the this and the other aforesaid factors makes the growth rate of India slow down significantly.

Food shortage and higher crude oil prices in the world has had a strong impact on all the developing economies, it has made it difficult to rein in the inflation and keep it under acceptable levels. As the central bank (RBI) cannot come up with a more lenient monetary policy, there is a need to find fresh sources of investment and attract the FIIs and FDIs back into the country.The Retail sector has done decently well in the recent past with investment from the private sector. It has generated significant jobs as well as contributed towards GDP. Indian consumers have shown that they can spend and are even ready to spend a bit higher than usual for the convenience these retail outlets provide them. Importantly the Indian middle class is ready to pay for the experience and convenience along with the price of the commodity thus making the retail sector a lucrative business to be in. The Middle class is also expanding and the penetration levels of retail outlets is way below the expected levels even in the major cities, which means there is sufficient scope for new players and further expansion. When Private players were allowed to invest in retail outlets fear was expressed that the roadside Stores would be history or the vegetable markets which my generation has grown up seeing would vanish. After some 5 years of Private players in retail sector, neither have the road side stores died out nor have the vegetable markets vanished, both have carved a niche for themselves and a method to co-exist.

With investment from FDIs within the boundaries specified by the government will help to further extend the good work that local private players have done. It would provide benefits to the consumers and also pave way for innovative products from the local entrepreneurs. Like any other sector, FDI in retail has it’s own positives and negatives. Studies done in developed countries indicate no significant effect on employment or better returns to farmers, it also indicates that inspite of better technology and supply chain practices there is a food shortage in the world. Yet China’s success in allowing FDI in retail and helping large number of people to move out of poverty is for all of us to see and learn from. Also the technological know how that foreign players could bring in could help in improving infrastructure related to cold storage and supply chain to reduce waste and prevent food shortages within the country. India often sees significant food crops getting destroyed or wasted due to lack of proper storage or logistics.

The benefits of FDI in Retail would be

– Stem the reverse flow of $
– Stem the depreciation of Rupee [More supply of $]
– Positive effect on Food Shortage [cold storage, supply chain practices, infrastructural improvement]
– Positive effect on Inflation [strong Rupee and better food supply will bring down cost]
– Lower inflation gives leeway to RBI to ease their Monetary Policy
– Boosts Economic Environment
– Boost Sentiments of the Corporates
– Generate new Jobs
– Option for innovative products developed locally – encourage entrepreneurs

Inspite of all the listed positives, we must understand that FDI in retail is not a Panacea. Other policy measures would still be required to sustain growth and alleviate poverty. Measures need to be taken to prevent factors that depreciates India’s value as an Investment Destination. Corruption is one big factor that needs to be dealt with. It’s impact on the Telecom sector is quite well known. Telecom Industry was a booming industry in India and had tremendous pace of growth, it also attracted large international players from across the world to invest and set shop. It was one industry that was growing and yet the cost per call was decreasing constantly. This was due to the increasing subscriber base and the tremendous potential that an ever expanding middle class and rapid urbanisation held . Yet the 2G Scam and the follow up taxation policies in the sector has slowed down the growth of the industry. These all incidents hurt the investors sentiments and they feel less confident in dealing with the government and agreeing to any clauses. Coalgate scandal is just another case in the point. We need to learn from those mistakes and deal with the FDI in Retail or Aviation or any other industry with newer wisdom.

Nonetheless, at the moment FDI in Retail is a much needed shot in the arm for the Indian Economy. India has always provided a dichotomy of view points on various matters. As a market it has also defied some of the predictions and speculations of economists and political analysts alike. I would hence request people to do their own critical analysis and thinking on any matter and not trust or believe the view points that are put up in public by various parties, whether the ruling party or the opposition, as they have their respective vested interests and political skulduggery to deal with.

Anyone interested to know more about what other countries are doing to ensure level playing ground between Foreign players and local players in retail must read: