Why is it important to get retail regulation right

The policy on foreign investment in Indian retail has been placed in the context of moderating inflation by the Government of India's Chief Economic Advisor.

It is hoped that organised storage and transport chains will help cut nearly 40 per cent transport and distribution losses in the present farm-to-fork supply chains, one of the factors pushing up food prices to high and unsustainable levels.

This proposal of opening up the Indian retail distribution sector to foreign multi-brand players with deep pockets is welcome, and will surely be lauded by most of the stakeholders.

Allowing foreign direct investment (FDI) will not only bring the much-needed financial capital into the sector, it will also bring in new technologies for storage and transport management.

That, in turn, will lead to efficiencies that will presumably translate into lower prices and better quality for consumers.

Moreover, it will take some pressure off Indian negotiators in the different investment and trade negotiating forums where the country is routinely castigated for its restrictive policies in key economic sectors.

Notwithstanding the fears and political dogma, the prognosis of the traditional retail sector's ability to hold its own against corporate players in the organised sector has been good.

Experience shows that rather than decimating the traditional retail shops, competition from the organised sector in the past few years has, in fact, spurred the traditional retailers into upgrading to modern formats with convenient and better organised displays, ICT-enabled storage and procurement management, and electronic billing counters.

It has also improved their services and customer-interfaces by making home deliveries and customising the offerings to specific consumer preferences.

As a result, in the past decade or so of its entry into the market, organised retail has not managed to increase its share from less than 5 per cent estimated in 2005.

Forecasters are, in fact, unanimous in their assessment that even if the share of modern retail grows from the present 4 per cent to the estimated 16 per cent by 2016, the absolute market size of traditional retail will be larger than that of organised retail.

Research on the impact of big players on small retailers in Brazil indicates that the India projection is not a one-off case. Since its opening up to foreign investment in 1994, traditional small retailers in Brazil managed to increase their market share by 27 per cent.

With the introduction of FDI and efficiencies of organised retail, it is hoped that the pro-active traditional retailers in India will also adopt some of the best practices by consolidation and collectivisation of purchases and integration with logistics operators for addressing the price and quality concerns of consumers.

However, to me, the disconcerting part of an otherwise positive proposal has been the collateral damage that the slew

of stringent investment norms may inflict.

Notably contentious are the proposed benefits from sourcing conditions and the cap on the number of outlets in big cities.

It has been argued for long that in the absence of a single market within India (even the introduction of the Goods and Services Tax will not remove all the inter-state border barriers that fragment markets and prevent efficient sourcing by retailers) and non-passage of the 2003 Model Act that seeks to amend the Agricultural Produce Market Committee laws, markets will remain oligopolistic leading to higher prices than is economically justifiable.

The sourcing conditions of at least 30 per cent procurement (including in food items) from small and medium enterprises will help push up the prices, which will then be passed on to consumers.

The other problem emanates from the entry restrictions that will be effected by the restriction on the number of outlets and limits to access in cities with designated population sizes (zoning regulations), done ostensibly to protect the traditional retailers in places with low population density.

While the exact impact of this policy in the Indian market is yet to be established, international experience of this popular entry regulation has been disappointing.

Econometric research on employment effects of such planning regulations in France, Italy, UK and US shows that these regulations have had a sizable negative impact on employment growth, especially in small retail shops, in addition to the productivity and efficiency losses that all the countries have faced after the introduction of the entry regulations.

Particularly illuminating is the experience in the UK, where such regulations changed the store strategies adopted by the organised sector.

In effect, the substitution of large stores with small chain stores run, or franchised out, by larger corporate houses led to the negative employment effect, as the latter ended up competing more directly with the traditional retail businesses, thereby compounding the net employment loss effect.

In the UK, planning reforms resulted in imposing sub-optimal store characteristics on both consumers and firms.

In semi-urban and rural India, the new wave of e-tailing (growing 32 per cent annually) indicates that traditional retailers are in any case facing competition from direct selling companies/online retailers, which have started to use the cash-on-delivery model for branded products in several lifestyle categories.

Hence, while adopting stringent conditions on entry barriers through zoning regulations or caps, policy makers need to be conversant with the inadvertent harm that such policies may cause to the intended beneficiaries in the longer term.

The short-run effects of a policy change may be politically motivating, but the longer-run effects are often more harmful.

The writer is senior fellow, CUTS Institute for Regulation and Competition; and research adviser, CUTS International. The views are personal