What changes does the e-commerce law
India’s Department of Industrial Policy and
Promotion (DIPP) made foreign direct investment (FDI) policy
changes to the e-commerce sector that came into force February
Although termed by the government as clarifying measures,
the changes have disrupted the e-commerce sector without any
stakeholder consultation. "The changes come as a diktat to
e-commerce marketplaces to operate purely as technology
platforms that provide some additional services such as
warehousing, logistics and order fulfilment, but restricting
their roles severely in the retail space," said
Vaibhav Kakkar, partner at Luthra & Luthra.
These measures came as a surprise to the e-commerce sector
and the deadline of merely a month for ensuring compliance was
troublesome. Amazon and Flipkart, which was acquired by Walmart
in 2018, have been especially hard hit. Several e-commerce
companies, including Cloudtail which is 49% owned by Amazon,
had to restructure their operations quickly and were forced to
withdraw a number of products from their platforms.
Under the changes, marketplace entities or their group
companies are not permitted to exercise ownership or control
over inventory. A company is deemed to exercise control over
inventory of a vendor if more than 25% of purchases of the
vendor are from the marketplace or its group companies.
Previously, through their wholesale arms, companies
purchased products in bulk directly from original equipment
manufacturers at significant discounts. They then sold these
products at a discount to vendors, who would then sell them on
the marketplace. 100% FDI under the automatic route was
permitted in the e-commerce sector, so this process was
However, with the new restrictions e-tailers will be
significantly restricted from acting as wholesalers to the
vendors who used to ultimately sell their products on the
platforms. Furthermore, marketplace entities or their group
companies are prohibited to exercise any equity participation
in the vendor. While direct equity participation in sellers is
clearly prohibited, it is uncertain if indirect equity
participation at the holding company level by the marketplace
entities or its group companies would also be restricted.
Another impact of the restrictions is that e-tailers will
not be permitted to sell private label products on their
platform on which they were earning higher margins and had
India FDI rules vexing foreign investors
How will the rules impact foreign
Anindya Ghose, professor at the Stern School of Business at
New York University, said that the new regulations are
semi-protectionist and will directly benefit local players such
as Mukesh Ambani's Reliance Retail. "Who has been pulling the
strings within the government to make this happen is anybody's
guess," Ghose said.
"These new regulations have not been well thought through
and present government interference and regulation as a
potential risk for global investors."
In the short term consumers, especially those of smart
phones and electronics goods, will be the immediate losers as
the deep online discounts from the likes of Walmart and Amazon,
will disappear. "Walmart and Amazon will feel more than a
pinch," said Ghose. "It is not a big stretch of imagination to
understand why Walmart may want to back out of the Flipkart
deal as these product categories constitute about 50% of its
Harish Bijoor, a brand and business strategy expert, said
that the key issue is that carefully made plans and joint
ventures can go awry with just one dictate. The key challenge
is an uncertain regulatory environment. Protectionism is
"Protecting the local traditional trader is going to be the
imperative of any government that seeks votes in a democracy,"
said Bijoor. "India is a nation of shopkeepers. At last count,
we had 14.6 million shops of every kind. The new e-commerce law
to that extent is protectionist and pampers the trader
community which is already upset with the government at
What are the most controversial
Up to now, 100% FDI in business to business e-commerce was
permitted under the automatic route, which essentially allowed
marketplace entities and their group companies to act as
wholesalers to the vendors who were ultimately selling products
on the platform. However, on account of these new restrictions
on inventory control, more specifically the 25% restriction,
e-tailers will be significantly restricted from entering into
such arrangements going forward.
"By introducing these disruptive measures the government
seems to have changed the rules of the game midway," said
While the objective of the policy to create a level playing
field for small traders appears suitable, observers believe
that it is unfair that these measures would not apply to
domestically owned organised e-tailers. "These organised Indian
retailers having deep pockets would continue to pose similar
challenges for small traders," said Kakkar.
Further, the policy prohibits marketplace entities from
mandating vendors to sell products exclusively on their
platform. Such exclusivity provisions are widely prevalent in
commercial deals and these decisions may be driven purely by
commercial motives. "This restriction goes against the
principle of party autonomy and appears to be overboard and not
in sync with the objectives that are sought to be achieved,"
What spurred these changes?
These policy measures were introduced by the government to
appease traders associations who were lobbying against the deep
discounting by e-tailers and to ensure a level playing field
for small traders operating through brick and mortar stores.
The changes aim to ensure that e-tail should remain a pure
marketplace only and their role should be primarily limited to
facilitating transactions between buyer and seller through a
technological platform. The idea is to make it difficult for
marketplace companies to influence the prices of products to be
sold over e-commerce platforms.
Vinay Joy, partner at
Khaitan & Co explained that although FDI up to 100% was
allowed under the automatic route for e-commerce, FDI in
entities engaged in the inventory-based model was expressly
prohibited. The issue was clarified in a press note issued by
the DIPP back in 2016. However, traditional retailers in India
felt that the wording was not stringent enough and that the
intended goal of the regulation was not being achieved.
Joy added that with the Indian general elections being held
in 2019, the government’s decision to bring in
stricter rules for e-commerce is not only to plug the alleged
gaps in the FDI policy, but also to create some goodwill with
brick and mortar retailers.
How are foreign players
Since no extension was given for the February 1 2019
deadline, e-commerce companies began restructuring their
ownership in the preferred sellers on their platform to ensure
compliance with the new guidelines.
Amazon has brought down its equity stake in Cloudtail to
less than 25% and has initiated the same process for Appario,
meaning that under the FDI rules these entities are no longer
considered as group companies of Amazon. Several private label
products are currently unavailable on the platform, and some
that were previously sold through preferred sellers are now
being sold by third party sellers.
Some observers remain optimistic: "The biggest companies are
revamping their play," Bijoor said. "Investors who had put deep
money into the old-play are having the carpet pulled from under
their feet. It will take time, but they will bounce back."
The DIPP has not clarified whether equity participation
refers to direct or indirect participation so this is still up
for interpretation. "Structures where subsidiaries of an Indian
owned and controlled company carry out e-commerce activities on
platforms may be workable,’ said Joy. "But until
additional clarity is provided, the viability of such
structures will remain debatable."
Given that the government has changed the rules of the game
midway with policy changes, in the event that there is a
significant decline in sales effected through these platforms
the possibility of foreign owned e-tailers invoking the
provisions of bilateral investment treaties cannot be ruled
out, Kakkar said.
While these disruptive policy measures have definitely
created some temporary setbacks for e-tailers, it remains to be
seen how much of an impact these measures will have on total
sales on platforms in the long run, and, whether these measures
will achieve their intended objectives.
Failure to enforce contracts damages Indian