During hearing on a public interest litigation [PIL] in Delhi High Court [DHC], on October 31, 2018, the Enforcement Directorate [ED] informed that it is investigating alleged violation of the Foreign Exchange Management Act [FEMA] against foreign majors such as Amazon and Flipkart. The specific charge is that these companies have violated the extant norms for foreign direct investment [FDI] guidelines as contained in Press Note [PN] 3 [2016-17].
The PN 3 allows 100% FDI in the ‘market-place’ model for e-commerce. An entity working on this model offers a platform to sellers and buyers to conduct transactions. It acts as a facilitator by offering them services such as booking order, raising invoice, arranging delivery, collecting payments, handling rejections etc. It can’t own stocks and can’t sell directly to the consumer [B2C].
The above permission is subject to riders. The market-place entity cannot permit more than 25 per cent of total sales on its platform from one vendor or its group companies. Further, it can’t directly or indirectly influence the sale price.
For an entity owning stocks and undertaking direct selling to the consumers [‘inventory’ model], FDI is prohibited.
To understand whether the companies are complying with the regulations or not, let us closely look at how they conduct themselves in the supply chain.
In step-I, a foreign company operating in the market-place model appoints entities majority owned by it as wholesalers and distributors. Under the extant rules, 100% FDI is permitted in wholesale cash and carry business. So, it can have full ownership and control over the wholesale business.
These wholesalers/distributors [or 100% subsidiaries of the entity] invest heavily in the creation of procurement/sourcing, handling, storage, distribution and all other infrastructure necessary for consummating a purchase and sale transaction. They buy a wide variety of items in bulk from the brand owners/manufacturers including those located in foreign jurisdictions.
In step-II, the wholesalers/distributors sell to vendors at a discounted price [in certain cases, depending on the item, the discount could be a high of 50-75%]. In step-III, the vendors sell the stuff on the online market place owned by the foreign major for which all relevant functions viz. booking order, raising invoice, arranging delivery, collecting payment, rejections etc are carried out by the latter.
The rules under PN 3 provide for a single vendor accounting for up to 25% of total sales on the market platform. So, there can be a total of 4 entities – each with a slice of 25%. This enables the owner of platform to exercise better control.
It may thus be seen that from sourcing, purchase, handling, stocking, distribution and sales to consumer – almost all essential components in the supply chain are handled by the e-commerce major [read: Amazon/Flipkart] and its subsidiaries. The vendor who is supposedly selling on the platform has absolutely no substantive role in conducting the transaction.
Now, if the vendor has no role [no value addition to make] then, the e-commerce company might as well exclude/drop him/her. But, under the subsisting eco-system, it can’t even contemplate; for the moment it does that it will be deemed to be under the inventory model wherein, the entity undertakes direct sale to the customer [B2C] and FDI is prohibited.
The e-commerce major recognizes the inevitability of engaging with vendors only to remain in compliance with the extant regulations. These vendors are retained merely for documentation to show that the ownership of stock rests with them. These could even be paper entities or proxy sellers.
With this backdrop, let us get back to the charge. Are the foreign majors violating the foreign exchange regulations under FEMA? Will investigation by ED lead to substantiation of the charge? Will the court endorse it?
The investigation and legal proceedings will take their own sweet time. Meanwhile, a cursory assessment would lead one to conclude that they need not worry.
Any violation of the Act would arise only if it can be proved that foreign investment has come in violation of the guidelines. The PN 3 allows 100% FDI in market place model for e-commerce and investment is made on this very platform. Although, in reality, e-commerce company holds the stock and is engaged in B2C as well, it will be nearly impossible to prove.
This is because the way provisions under each category viz. market place and inventory model have been crafted, the dividing line between the two is very thin. The only differentiating factor is the ‘ownership’ of the stock which the foreign major can easily circumvent. The ingenious bureaucrats have done it to ensure that MNCs do not play foul of the guidelines.
The moot point is 100% FDI in Indian retail is already in place – though camouflaged under a fancy nomenclature viz. ‘market place’. This shows that Modi – government is unambiguously in favor of FDI in retail which indeed is the way forward. India needs a lot of foreign investment to plug the voids in our handling, storage and distribution infrastructure, make way for improved technologies, give more choices to consumers at lower price and create jobs.
Yet, it does not want to let this be known to the public at large as it feels that such an admission would antagonize BJP’s core constituency i.e. traders class consisting mainly of ubiquitous ‘mom-and-pop’ stores. This fear is unfounded.
The government should get rid off this fear and come out with a clear-cut pronouncement. It should put in place a uniform policy to allow 100% FDI in retail without any riders. All artificial distinctions such as market place versus direct selling; online versus offline; food versus non-food etc should go.
[It should run an awareness campaign to show that foreign investors in retail pose no threat to ‘mom-and-pop’ stores; that the latter can co-exist with the former and even grow.]Now, that the country is already in election mode, a decision on this, if at all, can only be expected in 2019.