labels: rex mathew, retail, economy - general
Retail FDI and Inflationnews
17 February 2007

If the government is serious about tackling the price rise in primary food articles, it should move quickly to allow the Wal-Marts, Tescos and Carrefours to come and set shop in India, says Rex Mathew.

Over the last couple of months, rising inflation may have given sleepless nights to out economic policymakers – both at the North Block and at Mint Street. Okay, that may be a bit too much to expect from our officialdom. Rising prices may not have disturbed their sleep much, but at least they wear a worried look and their actions now show signs of urgency in tackling the stubborn price rise.

While the RBI followed up its 100 basis points hike in CRR announced in December with a 25-basis points increase in the repo rate and another 50 points hike in CRR, the government has been busy reducing import tariffs on a host of commodities and banning the export of wheat besides reducing retail fuel prices.

The RBI can be expected to go in for another round of rate hikes in April, or even before that, while reports suggest that the prime minister has asked for an across the board 5 per cent cut in import tariffs in the next budget.

While these measures may cool prices, it will be only marginal as the structural and logistical problems behind the price rise remain. While prices of manufactured products have steadily gone up because of higher demand and rising capacity constraints, it is the rise in prices of primary food articles which is more worrisome as it hurts the less affluent consumers the most.

Behind costlier food
Apart from the periodic price rises because of crop failures, much of the higher food prices can be attributed to the multiple layers in the distribution system besides inefficiencies and lack of proper infrastructure in logistics.

The gap between farm gate prices and final retail prices is very high in India because of these factors. Despite this, policy makers have hardly given any attention to bring in structural changes except half-hearted attempts like agricultural marketing committees and market interventions through highly inefficient PSU bodies.

As a very large percentage of farmers in this country either have marginal or small land holdings, they cannot build sufficient storage facilities to keep their produce. Because of the extremely fragmented distribution network, no major farm-support distribution or storage firm has emerged. This has prevented the establishment of sufficient logistical infrastructure including cold chains from the farms to retail stores.

Though transportation facilities have improved significantly, mostly because of the expansion and up-gradation of the road and rail networks, the transport fleet comprising trucks and railway wagons are still not adequately fitted out to handle perishable food items. Packaging and handling of food is way below acceptable standards. All these result in huge wastage of perishable agricultural produce. It is estimated that more than 35 per cent of the agricultural output in this country is wasted because of inadequate infrastructure.

We have now become accustomed to increasing cases of farmer suicides even when prices of farm products are rising at the retail level. It is well known that farmers hardly benefit from any price rise while the many layers of intermediaries enjoy high margins. Even when farmers are forced to sell their produce at throwaway prices in times of bumper crops, prices at the retail level remain higher by many multiples.

The situation is worse in states, which depend on neighbouring states for their supply of farm produce. For example, prices for most vegetables in Kerala are on average double those in nearby Tamil Nadu from where most of the produce comes to the state. The distances to Kerala from the major markets in Tamil Nadu like Coimbatore or Nagercoil are only around 200 km, which should only add marginally to transportation costs. Even after accounting for wastages in transit and handling, price mark-ups of 100 per cent or more prevail.

The only people who benefit from this are the intermediaries, at a very high cost to the farmers and consumers. With their financial clout, though only a very small percentage of them would be taxpayers, they have managed to keep politicians on their side. It is no secret that much of the funding for political parties in semi-urban and rural areas comes from powerful local traders' lobbies.

How would FDI in retail help?
To bring about a structural change in this system, the layers of intermediaries need to be cut down. This can be achieved only by allowing large companies who have the ability to set up end-to-end distribution and logistics networks by deploying the latest technology and information systems. Storage and other logistical infrastructure should be improved substantially to reduce wastages and this also needs large players who can make the required investments.

For all the charges against big retailers like Wal-Mart, it is an established fact that it is the rapid expansion of organised retailers, which helped control inflation in the US over the last decade and sustain the economic momentum in recent years.

Wal-Mart and deep discount stores like Costco have helped in keeping consumer price inflation by continuously driving prices down. True, part of this was achieved through import of cheaper goods from China. these also played a major role in improving the efficiency levels of American suppliers as well.

The obvious question would be why we should allow foreign companies instead of promoting domestic retail companies?

The fact remains that most of the existing retailers continue to depend on the very same intermediaries who supply to the corner grocery stores as well. Despite all the mega investment plans announced in the domestic retail sector, no large retail company barring Reliance Retail has outlined plans to set up a nationwide network to source agricultural produce directly from farmers and set up storage infrastructure.

It is not that the huge opportunity to cut down intermediaries and capture the immense cost savings is completely lost on these new retail entrants. They are probably being held back by the huge investment required and the associated financial risks. Most of them also lack of large-scale project implementation expertise, which is essential to pull off such ventures. It is no surprise that the only one who is venturing into it is Reliance, which has decades of expertise in implementing some of the largest industrial projects the country has seen, most of them ahead of schedule.

The big global retailers have the expertise in building even bigger sourcing networks and have the financial muscle to invest in infrastructure. They would also bring in systems and practices perfected over decades, which would only benefit the retail industry as a whole and ultimately the consumers.

Allowing foreign retailers could have significant long-term benefits for domestic farmers. With proper infrastructure, India can easily become the food basket of the world as there is no crop, which cannot be grown in vast country.

Food bowl of the world
Just as India is one of the lowest cost manufacturers and service providers, it can also become the lowest cost source of farm produce. Large foreign retailers would increase their sourcing from this country once they establish the required infrastructure and become the conduit for our farm produce to reach global markets, which would provide an impetus to the growth of Indian agriculture.

It barely requires much imagination to perceive what the Indian economy can achieve once the low-growth farm sector has the impetus to keep pace with the growth of the industrial and service sectors.

It is nobody's case that entry of organised retail would not affect the small retailers and street corner shops. However, the adverse effects of big retail are often exaggerated. Experience in mature markets has shown that a large percentage of small retailers remain in business through innovative strategies and services, exploiting select market niches.

It is utterly preposterous to argue that a minority group of traders should be allowed unfettered to continue seeking unfair rent in the form high margins by squeezing the vast majority of farmers and consumers alike.

To block the entry of foreign retailers on the pretext of protecting small retailers and corner stores while allowing large domestic retail companies to expand without any controls is absurd.

It is even more mystifying to read of the highest political leadership falling into this trap. But the ruling party and the government are not the only ones to be blamed when this is probably the only policy for which the support of both the opposition and their own Left allies is assured.

If the ruling party and the government are sincere about the repeated references in every communication to "protecting the common man and the farmer", they should move quickly end the stranglehold over food prices of the middlemen.

Logically, this can be best done by allowing large retail entry in to the country to set up direct sourcing from farmers (the way Pepsi Foods has done in Punjab). Allowing at least 51-per cent FDI in organised retail would be an equally logical corollary to facilitate direct sourcing by retailers to break the monopoly of the middlemen.

That would be a significant reform, which would push the growth of the farm sector that sustains around 70 per cent of the population, and simultaneously add to the growth momentum of the Indian economy for a much longer period.

 search domain-b
Retail FDI and Inflation