Cows & Convertibles – Regulate India's Roads, not its Economy

I have been wanting to do a post about on further deregulating the Indian economy for some time now, but have just not been able to gather the enthusiasm… But after being stuck in the heavy traffic, moving barely 4 kms in over 40 minutes and with another 20 kms to go, I pulled out my laptop and started typing.

I saw beggars knocking at cars' windows, and children trying to sell flowers. A plebeian man was urinating in a dark corner where the streetlight wasn’t working. Another old man flicked a cigarette butt out of his car’s window in the direction of what was a street tree, but had become a garbage dumpsite thanks to relentless littering by vendors and hawkers, who were selling assortments ranging from tea, golgappas, kebabs, to plastic toys and stationary. As we moved a few more meters before stopping again at the traffic lights, a beggar with a deformed face knocked at my window, and moved on to the car next to me when I told him I had no change for him. Just then, my driver pointed towards an accident site, which was probably the cause of the traffic being so congested. A minibus (capacity: 24 seated + 15 standing) had rammed into a bike and a taxi. There was a small pool of blood thereabouts, but I guess the paramedics had already taken the victims to the hospital since no victims were in sight. We drove on.

Over the next few kilometers, I lost count of the number of construction sites. This sight of unfinished buildings, numerous cranes, massive stacks of bricks, piles of sand, and hundreds of migrant laborers rushing to complete their tasks, was gratifying in a strange way. The notion of India Under Construction was a fascinating one. However, just then I snapped back to reality as the driver slammed the brakes suddenly – an bunch of old drudges, carrying what looked like sacks of cement, were running across the street, totally oblivious to any sense of traffic and road-safety behavior. “You moron! Are you blind?” screamed my driver, and then turned to me, “Do you get to see such things in other countries?” I just smiled, but kept quiet.

Throughout the journey, I had noticed that the sidewalks were being used for everything except walking, forcing the pedestrians to walk on the streets, which in turn forced the cars to slow down and be careful not just about other cars, and traffic lights, but also pedestrians. Adding to their woes, the potholes were so aplenty that it navigating though them felt like a videogame challenge.

By the time we reached the airport, I was already worn out, and I wasn’t even the one driving. But I had realized one thing – what gives India such a poor image. It’s not the inept social structures, institutions or dirty politics as laymen usually jibe – politics, everywhere, is dirty by its very nature; and our democratic social structures and institutions are among the world’s finest. It’s us, the people! We lack civil sense, and are always looking to cut corners. We cross the street wherever we find convenient (instead of on a zebra crossing), and drive through a red traffic light (with no regard for the law). We, the citizens of this country, have accepted the red tape as standard practice; to litter or urinate on the streets as a norm. We have become impatient to wait for the traffic lights to turn green, or to walk a few extra paces till we reach the crossing. We cheat on our taxes, and bribe guiltlessly to cut corners, and often seek a bribe to do our jobs too. And yet we seek more and more freebies. We nag about working overtime, but we always seek a raise. And worse of all, we feel proud of it all. If someone points any of this out, or publically mocks us (BBC’s Top Gear being the most recent case in point), we start condemning them and demand immediate apologies without thinking twice that perhaps our behavior has genuinely given our nation and its people a despicable image.

Yes, the government, or the local municipalities rather, should look at this stalemate on our roads (both, road conditions as well as civil sense among the masses) as a serious predicament. As disposable incomes continue rising, the rising number of cars (more affordable now) is only going to worsen the situation. Are our roads ready to accommodate all those new cars? Some among us have managed to afford Ferraris or Bentleys, but do we have the roads for them? Could you imagine an IT entrepreneur in his Ferrari in Bangalore, trying to navigate though potholes, or a banker from Mumbai trying to shoo away beggars from his Bentley? Could you imagine an Industrialist from Kolkata trying to navigate through a swarm of pedestrians on the streets while cheeky bikers are riding past on the sidewalks? Or imagine a political lobbyist from Delhi waiting for the cows to give way to his newest BMW. These images are not just figments of my imagination, but true incidences.

Yes, there are new highways, new roads, but the same old 3^rd world mindset prevails. Even Bollywood celebrity Mr. Amir Khan has been campaigning (on TV) about civil sense – I wonder if his efforts have been fruitful. I’m no expert on urban planning, so I won’t pretend to sound like one, nor make any airy suggestions. However, having lived overseas for a decade, and having traveled a fair bit (3 continents covered so far), I’ve witnessed better civil sense in just about every country I’ve been to when compared to India. So please allow me to share a tiny wishlist if I may: I would like to see a cleaner city (more dustbins please). When driving, I’d like to see less chaos and some orderly traffic flow (and pedestrians using the sidewalk please).I do not want to see men urinating on the streets (public toilets please). Instead of hijacking every street corner possible, I want to see hawkers and vendors in an organized market-like setup (municipalities could perhaps consider Marrakesh’s food-stalls in Djemaa el-Fnaa, or the night markets which are already popular all across Asia as models to adopt). Readers who’ve never been to India might find these as hilarious 3^rd world problems, and it is just that. But, it’s torturous enough to make me write about it.

As for regulation in the economy, lets save it for some other time, shall we? Its 2012, and while people are talking about what they want from this year, this is what I want from 2012, or 2013, or even 2020 – or any year within my lifetime for that matter.

FDI in Indian Retail II

In my previous post on FDI in Retail, I kept the focus limited to numbers & stats, mostly formulated by consultancy firms. The people behind those projections happen to be some of the best brains in our country (handpicked by their employers at IIMs or Ivy League universities). So their analysis in my opinion carries more reliability than most government officials, who are either uneducated (I did not use the word illiterate because the definition of a ‘literate’ in this country is laughable) or too ignorant, or have vested interests (the most probable case). If questioned about their stance on FDI, or asked to explain that stance, they get agitated but fail to provide even one plausible implication of their stance. Sad but true!

So far, the critics of FDI have given reasons along the lines of the following:

• Kirana shops will close. International sourcing will destroy Indian MSMEs too. This will cause unemployment.
• Farmers will get exploited.
• International firms (with deep pockets) will form monopolies and manipulate prices. Hence, the consumers will also be exploited.
• The Gandhi family wants to bring in FDI to benefit their “foreign cronies”
• The manner of the policy announcement was “inappropriate” since the Congress did not do adequate “consultations” with the allies and opposition parties. 

However, if anything, these claims have been nothing but populist in nature and their ruckus so far has gained them hefty support from the poorly educated vote-bank, which is not expected to know any better. Some political parties and their supporters seem to be too preoccupied with the Luddite Fallacy, which simply put, is a belief that labor-saving technologies will cause unemployment. As you can tell, the problem with this is that nobody (neither individual nor nation) can progress, let alone innovate, holding such a premise as core value. So it comes as little surprise that when the Prime Minister made an executive decision, the opposition created a pandemonium, both in parliament and on the streets, and forced the government to suspend the proposal in the name of democracy.

Now then, I doubt I need to remind you of how Protectionism hurts the economy of the country that imposes it. Not only does it disincentivize competitiveness and specialization, thereby deterring potential exports, but it also supports incompetent businesses. One does not need to look too far to validate this as our own history offers enough pointers. Businesses that were protected from foreign competition eventually got complacent and did not bother to innovate to stay competitive. Such complacency sets in to all businesses that are protected as they do not feel threatened by competition and hence they become exploitative in nature themselves. I’m sure you can think of a few such businesses yourself. Personally, I am an advocate of the notion that competition brings out the best of any business, and those that get wiped out were obviously not competent enough. Organized retail – though currently only 6% of the total retail market – is here to stay and is expected to rise to 21% over the coming years. This means that the Kirana shops will not be facing competition for the 1^st time.

In fact, judging by the VAT collections of the kirana stores between 2000 and 2010, which increased from Rs 3300 Cr to Rs 8300 Cr, one can only say that they have done well to hold their place despite the emergence of organized retailers (See graph). If anything, this would be another opportunity for them to cement their place in their neighborhoods. How? Consider this example of this shopkeeper in Delhi :

In 2009:

• 500 sq feet store with typical kirana layout and design, open 16 hours daily
• Had 4 employees (2 sons and 2 hired), and total of 448 employee hours every week (4 employees x 16 hours x 7 days)

In 2010, it was time to innovate (& renovate) :

• Repainted walls, added 3 shelf racks, 2 fridges, and 1 air-conditioner
• From Kirana format, it migrated to the self-service format
• Renovation Cost = Rs 90,000 & Time = 45 days

In 2011, post renovation results:

• 80% growth in sales
• Employee hours reduced by 25% to 336 hours per week (2 employees could now work part-time 8 hour shifts)

This is a true story of a kirana shop embracing change, modernizing, and as a result, enjoying higher sales and lower costs, which translated to better profit margins. An average kirana shopkeeper (working in meager conditions) does not take home more than Rs 10,000 – 12,000 per month. So when his sales nearly doubled (for the sake of simplicity, let’s assume that the decline in wage-bill was equal to the rise in his electricity bill), his improved profits (and work environment) could go a long way in improving his livelihood. He could potentially scale up his purchases and hence improve his bargaining power; perhaps he could eliminate an intermediary, thereby further lowering his costs. What he actually does with that extra income could be anybody’s guess, but the key takeaway here is that competition brought the best out of him. Had there been no pressure from bigger and fancier stores opening around Delhi, he might never have bothered doing what he did.

Next, I want to draw your attention to the graph. It is a comparison of the rise in CPI (Consumer Price Index) in 6 cities between 2000 and 2010. As you can see, cities with more organized retail – Mumbai, Hyderabad and Delhi – had faced less inflation (measured by change in CPI) compared to other cities – Amritsar, Kanpur and Nagpur – where retail is relatively less organized. This is essentially because organized retailers have bargaining power that individual small shops don’t. And while the scale of our domestic organized retailers is not very large, it still managed to keep inflation significantly low. Now, if, or when, the government’s better sense prevails and FDI is finally permitted, the inflation will be even lower.

In my last post, I already highlighted how organized retail (with FDI) would bring superior scalability, eliminate unnecessary intermediaries, and establish a high quality back-end infrastructure of international benchmarks. One thing I would like to add to that list is that it would lower Shrinkage Cost, which is the cost of slippages such as employee thefts, vendor faults, administrative errors, shoplifting, etc. This, in case of India is as high as 4% of total sales (read: losses) compared to a benchmark of only 1.5% globally. Furthermore, According to Technopak, while Indian retailers currently hold their inventory for an average of 128 days, their foreign counterparts hold their inventory only for 38 days because of their ability to source directly from the producers. That statistic alone shows that their efficiency in inventory management is 300% higher. Statistics aside, foreign retailers will also instill professionalism in their dealings (paying the suppliers on time, no worker exploitation), and inculcate a strong work culture benchmarking best practices.

According to the DIPP, India produces about 180 million tons of fruits and vegetables, but has a cold storage capacity of only 23.6 million tons (5,386 standalone units). That is a deficit of about 87%, and according to CRICIL causes losses worth a whopping Rs 10,000 Cr annually. What’s worse is that more than 80% of that cold storage capacity is wasted on potatoes alone. Sadly, the fact of the matter is that currently, India is relying on infrastructure that is outdated by decades. It does not have a proper logistics network, but just a number of warehouses and transport offices scattered across the country. As the country (and its citizens) develops, it is going to need adequate infrastructure in place to facilitate its growth ambitions. The Planning Commission of India estimates that India needs an investment of Rs 60,000 Cr (about $13 billion) in its agricultural infrastructure alone. Only way that this is possible is if the government puts its politics aside and allows FDI in multi-brand retail.

Let me give a scenario where the Indian retail industry is protected and FDI is not permitted. The outcomes of this would be actually very undesirable. Lets take a look:

• No Foreign Capital Inflow – With no inflow of foreign capital, the Rupee will remain weak for the foreseeable future and our expensive imports will continue to exert inflationary pressures.
• No Technological Breakthrough – This, in my opinion, is more important that inflows of capital. I already spoke about these so I will not repeat myself, but I will remind you that the value that the likes of Wal-Mart and Tesco will bring in technological knowhow would be priceless. While we tout about our software exports, it is crucial to realize that we lag far behind the world in actually adopting some of those technologies.
• Slower Job Creation – Since there will be no FDI, the growth in organized retail will come from our incumbent companies. But with business confidence so low, corporate balance so leveraged and the cost of credit (interest rates) so high, the growth is going to be much slower. This means that fewer jobs will be created than otherwise.
• No Infrastructure Development – I think it’s about time we smell the coffee and admit that the Government lacks the ability (and perhaps political will too) to eliminate infrastructure bottlenecks that cost us over 2% of our GDP every year. For those who think I’m being over-cynical in this regard, just compare the quality of roads that have been built in the last decade (try to focus on the damage) with the quality of infrastructure built over 60 years ago and is now probably declared heritage property (compare the damage). The potholes, the railway accidents, the filthy streets, and the overall neglect speak for themselves.

By now, I’m sure you get the picture. However, before I conclude, I would like to make one suggestion on this policy. That is to increase the 30% local MSMEs sourcing requirement to 50%. This is because giant organized retailers source about 30-40 percent locally anyway in order to achieve cost-efficiency. Furthermore, it makes little business sense in trying to sell grainy Chinese rice to an Indian basmati-loving consumer base. Hence, by imposing a local sourcing target of only 30%, the government is not doing any favors for Indian MSMEs. Secondly, I hope the Indian government doubles the definition of MSMEs from an asset base of Rs 5cr ($1million) to Rs 10Cr as overtime, in order to be able to meet the large demands of the retailers, the MSMEs will need to increase capacity and will then no longer remain in that MSME category since their asset base might exceed Rs 5 Cr. Moreover, opening up the multi-brand retail markets to foreign firms will also require India to rethink about the legal infrastructure – something else that India needs desperately since our legal system is very outdated. Issues such as taxation, labor laws, procurement laws, and food and safety standards will all have to be revisited. A nation with an economy developing at such rate needs a legal system progressive enough to match it strides.

Finally, the Indian economy grew at an aggregate of 105% between 2005 and 2011. Today, rural income is rising, and consequentially rural spending (demand) is rising. The rural demands in the same period (2005-11) grew by 35% for milk, 70% for vegetables, and another 70% for packaged and processed food items. This further shows that not only are kirana shops going to stay, but also that removal of intermediaries will give the farmers and other rural communities more disposable income will then improve the standard of living, and hence the social fabric of those communities (a positive externality). This however has one more implication. As these rural incomes rise, and the villages and rural areas are developed, new towns will be formed. Furthermore, there is already intense migrating from villages to big cities already. This will then make the procurement and logistics of food across the country a very complex process. Hence, in order to avoid chaos, adequate investments and careful planning needs to be put in place before it gets too late. FDI will bring in both the resources needed (capital and expertise) to do just that, and should therefore be seen as a boon to our supply chain, and hence, to our infrastructure thus the entire economy.

Concluding this post, I would only say that FDI in retail is something that India needs (almost desperately) and hence should embraced with both arms instead of resisting. It could add about 4-5% to our GDP every year. Take a look at the chart above. It shows the breakdown of the costs a consumer pays for tomatoes. The farmer gets only 30% of the final price, the retailer takes 21%, and the remaining 49% is distributed among other intermediaries. Considering that organized retailers could source directly from the farmers, how much value do you now think the intermediaries add?

A study by ICRIER (Indian Council for Research on International Economic Relations) came up with some interesting insight.

• The average distance from a consumer is 1.1km for a kirana store, but 2.6km for an organized retailer. In fact, 64% of the smaller kirana stores well less than 500 meters away.
• 35% of the kirana stores recognize their regular customers and give them credit. In fact, credit sales are makeup 22% of their total sales. These kiranas also know their customers’ tastes and can follow the changing tastes.  

Take a look at the graph below. It shows what FDI Liberation in the Retail Sector did for China. Why China? Because of the similar population size, and traditional agricultural economic roots. But the similarities end there. Anyways, the India-China comparison can be left for another day. For now, I've only brought this up to raise a simple question. Can liberating FDI do the same for Indian Retail sector? 

Let me give you an example. You realize that you are out of bread or eggs one morning. How would you make that purchase? Would you go to the big retailer in your city, or just downstairs to the nearest kirana store? What if you realized you did not have change? Or were crunched on time? In case you didn’t realize where I am going with this, I’m only trying to remind you that your neighborhood kiranas have a place of their own in the Indian retail landscape and the likes of Wal-Mart, Tesco, Carrrefour SA, etc. cannot take their place. If anything, it is 7-eleven that we should be worried about!

FDI in Indian Retail I

After 2 decades of procrastination, it seemed that India was finally opening up its underdeveloped retail market to Foreign Direct Investment (FDI). The landmark announcement  was  made  on Nov 24^th, when  the  Union  Cabinet  cleared the bill allowing 100% FDI in Single-brand retail (think: IKEA, LV, Apple, etc.), up  from 51% as it was until now. The announcement also  included a controversial  decision to allow 51% FDI in Multi-brand retail (think: Wal-Mart, Tesco, Carrefour, etc.).

While FDI in Single-brand retail segment has been welcomed, Multi-brand segment has caused hysteria in the Parliament, and cascaded on to the streets with retail stores across the country closing down for a day in protest against FDI (protesting seems to be the biggest trend of the year 2011). These strikes were organized by wholesale traders’ unions and other middlemen in the retail supply-chain, the biggest losers if the likes of Wal-Mart & Tesco come in. The non-functioning parliament cost the nation Rs. 1.5 Cr (15 million) per day, but the opportunity cost of loss of productivity & the cost of impairment of India’s reputation are anybody’s guess. The Prime Minister’s executive authority has now been questioned too. As his Congress Party pitched the idea to other MPs and citizens citing benefits like job creation and modernization of Indian retail, they did not get any support even from their own allies, let alone the opposition parties. The naysayers’ argument was that FDI in Multi-brand retail would put millions out of smaller shopkeepers (kirana shops) out of business, and also that international giants will form monopolies and exploit farmers.

Why would anyone in their right minds participate in such folly? Is it confusion caused by political noise? Or is it ignorance that’s fueling such dissent? Don’t people know better? Do they lack independent judgment? I think it’s absurd that people protest against something that they would actually benefit from. So in this post, I will share my views on the matter. As you can probably tell already, I not only support it, but also encourage it to be rolled out ASAP. I do think that a few tweaks should be made to the finer print. But before l share my views, let me list down some of the features of what the Government’s proposal says.

Salient features of the Multi-brand Retail FDI :

1. There has to be a minimum investment of $ 100 million.
2. 50% of the total investment has to be in back-end infrastructure.
3. Stores are permitted to open only in cities with a population of at least 1 million (10 Lac) people.
4. At least 30% of manufactured / processed products must be sourced from Indian MSMEs.
5. The government retains the right to be the first to source agricultural produce.
6. The Bill is just an enabler; it is essentially up to individual states to allow or disallow the retailers to open shop.

Salient features of the Single-brand Retail FDI :

1. Brand must already have presence in other countries too.
2. 30% mandatory sourcing from Indian MSMEs.
3. Must be branded during manufacturing.
4. Investor must be Brand Owner, and not a franchisee or a regional license holder.

At this point, allow me to throw some light on the situation. The backdrop has been that of a global slowdown, with Indian government being in the news for all the wrong reasons, ranging from scams to policy paralysis. With painfully high inflation, stunting economic growth and a weakened Rupee, permitting FDI was the Indian government’s stimulus package. Here’s how. Firstly, it attracts long-term capital into India which is both, less speculative and more productive in nature. Such capital investments in India (by both, international and domestic businesses) had declined recently. Secondly, this move would have brought technological knowhow and spur backward integration in organized retail in India. This would lead to drastic improvements in supply-chain infrastructure, especially in the domain of perishable goods, by replacing intermediaries who do not add any value with those who do. Before you jump to conclude that intermediaries are not being removed, but just replaced, let me explain what I mean. Consider the following numbers:

• Currently, there are about 5-7 intermediaries between the farmers and the retailers. This causes the price of vegetables and fruits to increase multiple folds. For instance, potatoes cost only Rs. 2/Kg in Nasik, Maharashtra (closer to the farms) but by the time it reaches New Delhi, consumers pay Rs. 18/Kg for it. That is a 9-fold price difference, and neither the farmers, nor the customers benefit from it.
• About 40-45 % of the perishable food produce gets perishes before even making it to the marketplace. This shows the value-destruction of the current intermediaries.
• According to rating agency CRICIL, India’s organized retail loses Rs. 10,000 Cr ($ 2 bn) annually due to wastage, mostly of perishable products like fruits, vegetables, fish, meat & poultry. While 15% of these losses occur at the farmland itself, another 25% is lost during transportation.
• The ratio of traders to actual retailers is 0.001. This means that for every 1000 retailers, there is only 1 trader. So the argument that single stores, or (Kiranas) will shut is flawed, and the number of traders who lose jobs is overhyped too. The intermediaries (about 15,000 currently) won’t be left unemployed; instead, they will get new jobs that actually add value in the supply-chain. Direct sourcing from the farmers can reduce supply-chain costs by 10-15%.
• About 85% of all farmers own only about 2.5 hectares of land or less. This gives then no bargaining power, and they end up getting exploited by the agents. Also, they are not working on a contract-basis, but on a contact-basis. Hence, they have no defense against current exploitation either. On the other hand, for example, Tata Chemicals helps the farmers working with Trent (contractually of-course) in assessing their land, and recommending the most suitable fertilizers and other technologies that could help farmers get a higher output from their land.
• According to consultancy firm A.T. Kearney, organized retail is currently only 7% of the $435 billion (approx Rs. 21 Lac Crore) Indian retail market but is expected to rise to 21% within the next few years. Food accounts for 70-80% of this. This is led by a consumption class of 400 million people with rising disposable incomes, and a steady rate of urbanization. 

Considering the above numbers, the case for organized retail is self-imposing. Indian conglomerates such as the Tatas, AV Birla, Reliance, etc have already been trying to strengthen their foothold in the Indian organized retail market. While they and other domestic players like Bharti, Future Group, etc. are already trying to eliminate the intermediaries, their scale of operations is not significant enough to bring about a substantial change in the condition of the farmers, or curb prices on a national scale. Furthermore, they lack adequate experience and technical knowhow in the retail domain to introduce any breakthrough innovations. The international players, on the other hand, can leverage their experience to bring the much needed reforms in the Indian supply-chain network by innovating logistics, introducing cold-storage systems, food-processing, IT systems, etc. 

Thirdly, Micro & Small-Scale Enterprises (MSMEs) will have a direct market to sell to and therefore will reap benefit similar to the farmers. In fact, the challenge for them will be to scale up their operations to meet the demand of these organized retailers. In such a scenario, they too will ramp up production scale and hire more workers. Some might even innovate and adopt newer technologies, thereby generating a larger positive spillover effect in their community.

The fourth benefit of FDI in retail will come in the form of a positive externality of making our workforce more employable. At present, several employers often complain of India’s current workforce lacking several key skills and hence being unemployable. Many workers in the current retail sector will not lose jobs like the politicians have been suggesting, but instead, be hired for their experience & understanding of the Indian consumer, and get trained for the new retail landscape. According to reports from the consultancy firm Boston Consulting Group (BCG), organized retail could right away create about 10 million jobs – 4 million direct and another 6 million indirect jobs. It would generate additional incomes of Rs. 73,000 Cr (approx $14.6 billion), and consumers would save about 1.5 Lac Crore (approx $31.25 billion) annually in their shopping bill. However this is only possible if significant scale is achieved and technology is applied, which is only achievable by allowing FDI in Multi-brand retail. The illustration below shows the current employment generated by Retail trade in some cities. These numbers will only grow post FDI reforms.   

These are just some of the more obvious benefits that we can foresee already, and I am sure there are more too. But there’s more to the retail FDI story than just the numbers I presented. I will do a follow-up post on this topic highlighting the bigger picture, and state my case as to why I feel FDI is going to benefit India. Until then, I leave you with this Illustration which appeared in Hindustan Times, showing how some other countries have opened their doors to FDI in their Retail Industry.