Foreign Direct Investment: What’s really holding online back

By Lalit Kumar

First things first. The Walmart-Flipkart deal is a masterpiece in terms of stitching together a structure and negotiation that allows the world’s largest retailer to make a direct play at Indian ecommerce industry’s huge potential. This deal is a great example of an acquisition of an Indian online retailer that’s in compliance with the foreign direct investment (FDI) rules applicable to online trading. Its meticulous structuring to ensure that FDI rules are adhered to for the acquisition are also a lesson in structuring. However, the challenge lies elsewhere.

It is the existing FDI rules themselves that are holding back the e-commerce sector. Scratch the surface, and one can see that most online trading companies in India with FDI follow FDI rules more in form than in substance. The reason for this is the stringent conditions that apply to online trading.


Complete compliance will never let companies freely do business in the manner such a business is supposed to be done. Here is when the ‘creative’ thinking and structures come handy, designed to follow the law only in its letter and more importantly to overcome the stringent conditions of the policy.

Only in India does a legal policy exist with so many distinct categories of trading. The Indian FDI policy provides for cash-and-carry wholesale trading; retail trading that’s divided into single-brand trading and multi-brand trading; ecommerce (online trading), which is further divided into the market place and inventory-based models; and finally, trading by not just a trader but someone who’s a manufacturer and trader. While a manufacturer is free to trade by any of these modes for all the other categories, different rules with different sets of conditions are provided in the FDI policy.

Interestingly, FDI in all these categories is allowed either through the automatic route, or government approval route. But when it comes to FDI in the inventory-based ecommerce model, it is disallowed. According to the FDI policy, inventory-based model of ecommerce means an ecommerce activity where inventory of goods and services is owned by an ecommerce entity, and is sold to the consumers directly.

The reason for the ban seems to be driven more by political considerations than genuine business concerns. It is a known fact that for several years, small and scattered kirana stores have opposed FDI fearing loss of their business by the onslaught from these gigantic online trading companies. Govts, too, traditionally are afraid that allowing FDI in this sector could result in losing votes of the trading community, and that opening this sector to FDI could be a political disaster.

Yes, over time, there has been gradual liberalisation in FDI in this sector. But successive governments have continued their political patronage and protection to traders. As a result, business has not grown to its potential. So, is the threat of foreign capital real? The controversy is that if Indian companies start getting foreign capital, it will squash the local industry. The reality, however, is that if at all the traders feel threatened, that can also be from competition from large Indian-owned and -controlled companies with deep pockets. The opposition to foreign capital is more of a politically driven issue than anything else.

From a business perspective, it makes little sense to think that the future lies in brick and mortar stores. Ecommerce is the wave of the future. Consumers who switch to online shopping are indifferent to the company being Indian or foreign-owned or -controlled.

So, the only real threat to small traders is the changing trends in shopping and consumer preferences.

In fact, foreign capital will be good for the overall growth of the sector, with great potential for employment and technological innovation, and opening India to a world-class shopping experience.

In any case, companies currently operating in the market place model, can’t be said to be operating accurately within the permitted conditions. They do cross the line and undertake an inventory-based model by using creative structures. So, it’s time the government realises this, and gets ready to bell the cat and allows foreign money in inventory-based online trading.

The first vital step is introducing and implementing new laws that seamlessly integrate doing of business, with the benefit of each stakeholder domestically and globally. Remove unnecessary restrictions on FDI. And, above all, allow the inventory model to operate unhindered.

(The writer is Partner, J Sagar Associates. The views expressed are author's own)