How the likes of Amazon have circumvented India’s FDI laws

Amazon has been sailing too close to the wind in India in an attempt to dominate the market for online retail, observers and market participants said. In the process the American multinational has, in effect, thumbed its nose at the policy-makers, whose ability to enforce rules and protect the little guy has been called into question.

The Indian government has crafted regulations, recrafted them, and clarified their meaning, all while Amazon uses every trick in the book to stymie the government in its plan to protect traders and consumers and help attain the vision of Atmanirbhar Bharat.

India has been cautious, and rightly so, in opening up the retail sector to Foreign Direct Investment (FDI) because the livelihood of millions of small traders is at stake. In the grocery segment alone, for instance, there are around 12 million mom-and-pop stores. It is only during the last 7-8 years that the retail sector has been slowly opened up for foreign investment, step-by-step and with stringent conditions. A free run for foreign retail giants like Amazon will sound the death knell for millions of these small traders.

In the retail sector, FDI is allowed in single-brand retail under the automatic route. It is also allowed in multi-brand retail but only with government approval and a lot of restrictions. The rules call for 50 percent of the total FDI money to be invested purely in the backend infrastructure. There are clauses for mandatory local sourcing of goods and services. Such entities cannot trade by the means of e-commerce and companies that have FDI can do multi-brand retail in only select states.

Rules are relatively easier on the e-commerce front. FDI is permitted in the pure marketplace model. However, it means that an e-commerce company can only provide a platform for third party buyers and sellers to come together and trade goods. It cannot buy, keep an inventory and sell the goods. Basically, it means that an entity with FDI or a foreign company cannot do e-commerce business under the inventory based model.

What Amazon has done
The FDI Policy of 2015 allowed 100 percent FDI in B2B e-commerce and not in B2C e-commerce. That meant entities like Amazon could not sell directly to the retail consumer. Therefore, they built complex structures to get around the law. One way was establishing B2B companies which were the recipients of large foreign investments from the likes of Amazon. In turn, these B2B companies were sellers on the online retail platform operated by Amazon. In effect, Amazon was able to carry on multi-brand retailing.

At the heart of Amazon’s quest is one of the largest untapped retail markets in the world—India. The US company is the unquestioned leader at home and it is head and shoulders above competition in Europe. China has shut out Amazon—its marketplace business was closed down last year—and that means India is vital to its growth ambitions. Which is why Amazon seems prepared to try any lengths to attain its aims in India, whose retail market with over 1.3 billion customers is projected to be worth $1.3 trillion by 2025.

The Seattle-headquartered company claims to be running its business on a pure marketplace model. (Under this model, the platform itself cannot buy, keep an inventory and sell the goods). However, since it entered India in 2013, Amazon has circumvented government restrictions multiple times to indirectly carry on multi-brand retailing in India.

Amazon did not respond to a detailed questionnaire sent on November 2. This story will be updated once Amazon responds.

It was only in 2016 that the government for the first time introduced a stricter policy which specifically defined inventory-based and marketplace-based e-commerce models. While 100 percent FDI was permitted in the marketplace model of ecommerce it wasn’t permitted in inventory based e-commerce model.

Conditions were imposed as part of the policy. It barred a marketplace e-commerce entity from exercising control of the inventory being sold. It specifically said that an e-commerce entity will not derive more than 25 percent of overall sales through its marketplace from its group companies.

The definition of a group company was laid out clearly. For instance, if a company A holds 26 percent of the voting equity stake in a company B or appoints 50 percent of the latter’s board of directors, then B is a group company of A.

Lastly and most importantly, e-commerce companies were banned from directly or indirectly influencing the price of products sold on their website, bringing an instant watch on the online heavy discounting wave which was giving a hard time to offline retailers.

These rules in effect legitimised the structures that foreign e-commerce companies such as Amazon were using, but it could do nothing to prevent them use their deep pockets to effect predatory pricing. Discounts continued and a few sellers, often group companies, continued to dominate sales to the detriment of other, small vendors.

“The lack of proactive enforcement gives these platforms an incentive to abuse laws. Since 2018 the Enforcement Directorate (ED) is looking at FDI violations against these platforms. It’s been over two years and the investigation has not seen the light of the day,” said Chanakya Basa, corporate lawyer and co-founder of law firm Knock Legal, who is representing the All India Online Vendors Association.

The 2018 tightening of rules
Consequently, in 2018, the government tightened regulations to ensure that foreign e-commerce companies could not continue to run inventory-based models through group companies while claiming to be pure marketplaces.

Press Note 2 of 2018 said an entity running an e-commerce marketplace shall not have control over inventory. It shall be deemed to have control of a vendor if more than 25 percent of the sales of such vendors are to the e-commerce entity or its group companies. The note also barred e-commerce entities from selling goods of any vendor in which, the entity or its group companies had an equity stake. It also prevented e-commerce entities from requiring merchants to sell goods exclusively on their platform.

Amazon again circumvented these restrictions. For instance, it modified the shareholding in a seller entity by holding 24 percent voting through an affiliate (not by itself or through a group company as defined) and also economically owning and participating in the sellers through affiliates.

Despite the laws and regular tweaks, foreign e-commerce companies continue deep discounting, predatory pricing, preferential treatment to select sellers and such practices that affect small retailers. The All India Online Vendors Association, whose members sell on Amazon and Flipkart, have alleged Amazon engages in unfair business practices in a case filed at the Competition Commission of India.

“These companies are flouting each and every rule set out in Press Note 2. They are into predatory pricing, funding losses, selling exclusive material and also having inventory,” said Praveen Khandelwal, National Secretary General of the Confederation of All India Traders (CAIT).

Khandelwal said that whenever an order is placed on these portals, they decide which seller will receive that order. “So they are forwarding almost 90 percent of the orders to their own shell companies. If we ask them who are your top 10 sellers, the same set of companies will be found being the top sellers in the last five years. So it clearly shows that they are controlling the entire inventory and it is their wish to whom they will process the order which is against the spirit of the rules,” he alleged.

The best bet is for the government to bring about a comprehensive amendment to plug all loopholes and arm itself with powers under the Foreign Exchange Management Act and and regulations to punish the guilty. Enforcing laws based on form should stop. It is high time that the enforcement of FDI laws in ecommerce should be based on substance. MoneyControl