MUMBAI (REUTERS) - The Indian state of Rajasthan has barred foreign direct investment in supermarkets, an ominous sign for global retailers who covet India's vast but fragmented retail sector if the country's main opposition Bharatiya Janata Party (BJP) comes to power nationally in upcoming elections.
The BJP is considered to be more investor-friendly than India's ruling Congress party but opposes foreign direct investment in supermarkets because of its impact on small shopkeepers. It unseated Congress in Rajasthan's state elections in December.
The Associated Chambers of Commerce and Industry of India (ASSOCHAM) criticised Rajasthan's policy reversal, made on Friday, saying it would "dent and shake" global investor confidence.
"If one party reverses the decision of its rival dispensation upon change of guards, the policy and political risks for global investors would definitely increase in India, scaring them away," D.S. Rawat, secretary general of ASSOCHAM, said in a statement.
In late 2012, the government of Prime Minister Manmohan Singh opened India's US$500 billion (S$638 billion) retail industry to foreign operators, allowing companies such as Wal-Mart Stores Inc and Tesco Plc to own majority stakes in Indian chains for the first time.
However, India left it up to individual states to decide whether or not to allow foreign retailers.
So far, fewer than half of India's 28 states have adopted the policy, making it harder for retailers to exploit economies of scale by setting up sourcing and cold storage networks that could serve stores in contiguous states.
Stringent local sourcing rules and worries that the policy might be overturned have also kept most global supermarket chains on the sidelines.
Polls show the BJP is on track to win the most seats nationally in elections due by May. However, no party is expected to win the 272 seats needed for an outright majority, meaning the biggest party will seek to form a coalition with regional parties.
"This is all political posturing ahead of the national elections. No government can come in and ignore foreign investors," said Harminder Sahani, managing director at Wazir Advisors, a retail consultancy.
"The most likely outcome is the BJP will scrap the existing policy and come up with a new one with additional conditions but they will come up with something," Sahani said.
Tesco, the world's third-largest retailer, in December unveiled a relatively modest plan to invest US$110 million in Tata Group's Trent Hypermarket Ltd to open stores in the states of Maharashtra and Karnataka.
Maharashtra is home to the Indian financial capital, Mumbai, and is led by a Congress party alliance. Neighbouring Karnataka, where the technology hub of Bangalore is located, is run by a Congress government.
"We have noted the decision of the state government and will bear it in mind as we consider our future plans," a Tesco spokesperson said.
In October, Wal-Mart, the world's biggest retailer, walked away from its partnership with India's Bharti Enterprises to set up retail stores, citing unfriendly regulations.
Wal-Mart still runs wholesale outlets in India.
Last month, the newly-elected Aam Aadmi (Common Man) Party government in New Delhi barred foreign supermarkets in the capital.
The Indian economy grew 4.5 per cent in the last fiscal year, or less than half its rate in the years before the global financial crisis, and sluggish investment due in part to inconsistent policies has contributed to the slowdown.
"From any investor's perspective - foreign or domestic - he is looking at how predictable the environment is in the future,"said Devangshu Dutta, chief executive officer of Third Eyesight, a retail consultancy.
"The policy framework and the overall environment are not encouraging the foreign investor to take that call," he said.