E-commerce growth depends on Indians getting richer.

Source: Exotica.im/UIG via Getty Images

Beware India's E-Commerce Bubble

Dhiraj Nayyar is a journalist in New Delhi. Trained as an economist, he has worked at the Financial Express, India Today and Firstpost.com. He is editor of "Surviving the Storm: India and the Global Financial Crisis."
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One sector in India’s economy seems immune to worries about the country’s uncertain policy environment: e-commerce. Even India’s exuberant stock markets, which enjoyed spectacular rises in the aftermath of Prime Minister Narendra Modi’s landslide victory last year, have spent the last two months self-correcting. The benchmark Sensex at the Bombay Stock Exchange has seen a 10 percent decline in value in the last 60 days as the reality of a still-sputtering economy and start-and-stop reform has registered with investors.

QuickTake India's Aspirations

None of that's dented the gold-rush mentality in Indian e-commerce. According to a new report, in the last 15 months foreign hedge funds, asset managers and investment firms have invested almost $4 billion in just 26 Indian technology and e-commerce start-ups.  Can India’s virtual economy sustain such a rally? There's plenty of reason to be optimistic, but an equal number of reasons to be cautious.

The most obvious attraction of the Indian market is its size and potential. India has 150 million active Internet users -- less than America’s 250 million and China’s 550 million, but still one of the largest such blocs in the world. A combination of demographics and technology should lead to an upsurge in these numbers in the next decade. Two-thirds of India’s population is under 35 -- the demographic that makes up the largest share of the country's Internet users. True, broadband penetration remains low and isn't growing rapidly, especially among the vast rural population. But the spread of cheap, Internet-enabled smartphones could help bypass the need for an extensive broadband network.  

While greater connectivity is necessary for an e-commerce boom, though, it's hardly sufficient. Ultimately, growth in the sector depends on Indians acquiring a lot more purchasing power than they have now. At $1,500, India’s per capita income is less than a quarter that of China’s $6,800. At India’s current GDP growth trajectory of 7-8 percent per year, it'll take much more than a decade to reach where China is today. Some investors may see hope in the fact that India’s economy is predicted to grow faster than China’s this year. But India’s latest GDP statistics are mired in confusion and China was always bound to slow down after it reached middle-income status. Investors need to be cautious about such comparisons.

India’s regulatory environment for e-commerce remains uncertain. There's no clarity on whether the government will allow 100 percent foreign investment in the space (something that's still not allowed in brick-and-mortar retail). India’s tax administrators, notorious for their arbitrary actions, haven’t yet developed a clear policy on e-commerce players, most of whom make losses; as valuations continue to soar, companies may face unwelcome scrutiny. Importantly, the same constraints which hobble growth of the real economy -- such as world-class infrastructure -- will undercut e-commerce, too. Terrible roads make deliveries difficult, while warehouse space can cost as much as in the developed world. Last month, the United Nations released a survey that ranked India 83rd out of 130 countries in terms of its e-commerce environment, judged by factors such as the number of Internet users, availability of secure servers and credit-card usage.

So far, the e-commerce industry in India is bleeding money. Between April 2013 and March 2014, the total sales of Flipkart.com, Snapdeal.com and Amazon.co.in, the three largest e-tailers in India, amounted to $85 million. Their combined losses were $160 million. Unlike in China, India’s e-commerce industry is highly fractured. The market leader Flipkart controls just 5 percent market share compared with Alibaba’s 80 percent market share in China. Not every firm that is receiving investment now will be viable in the medium run. Some consolidation will take place, especially if losses continue for a long period.

India may yet get its own Alibaba or Amazon, and those investors who bet on the right horse will make money. For the rest, though, this bubble is likely to burst.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Dhiraj Nayyar at dhiraj.nayyar@gmail.com

To contact the editor on this story:
Nisid Hajari at nhajari@bloomberg.net