Plans by Carrefour , the world's No.2 retailer, to open its first cash-and-carry outlets in India are a sign of optimism in the country's $450 billion retail sector, but foreign investors and some officials want more -- an easing of the country's tough investment rules.

Just days before Carrefour's announcement, Africa's Shoprite Holdings said it may quit India because restrictive foreign investment laws have hamstrung its growth, highlighting the many hurdles for foreign retailers.

India's retail industry is among the fastest growing in the world, but it remains heavily regulated, with strict limits on foreign investment. Even big local retailers face opposition in some states amid claims they cause massive job losses.

Some foreign firms had expected the re-election last year of a Congress-led government would open up retail to outside investment as it was no longer held back by communist allies who say such a move would hurt farmers and traders.

Analysts say opening up retail to foreign direct investment (FDI) may help bridge a yawning fiscal deficit, rein in food price inflation by curbing waste and create thousands of jobs.

But the move is a political hot potato and is off the table, as the left-leaning government eyes upcoming state elections and does not want to dent its populist appeal.

The government is not talking about FDI in retail at all, said Seema Desai, analyst at risk consultancy Eurasia in London.

It's not just the impact on kirana (small) stores, but also the impact on middlemen and wholesalers who are politically very powerful ... (and) the political backlash from within the party and the opposition. So the government will tread carefully.

I don't expect we will see any major moves toward retail FDI in the next year or so. It will happen in a phased manner.

WAITING GAME

Organized or branded retail makes up just over 5 percent of the total Indian market, but is estimated to be growing at more than 20 percent a year.

For years, Indian shoppers bought rice and soap in tiny neighborhood shops lacking freezers and well-stocked shelves, but who would often sell on credit and deliver at home for free.

Rapid economic growth, forecast at 7.2 percent in the year to March 31, and rising incomes in Asia's third-largest economy have drawn global retailers looking to offset sluggish home markets.

But foreign retailers have long been frustrated by Indian rules which permit single-brand foreign retailers to take up to 51 percent in a local venture, and limit multiple-brand retailers to franchise, license and wholesale cash-and-carry operations.

Marks and Spencer has a venture with India's Reliance Retail for apparel and homeware, while Tesco has partnered the Tata Group for cash-and-carry outlets. Germany's Metro also operates wholesale centers.

Shortly after the Congress-led alliance sealed its election victory last year, top retailer Wal-Mart Stores Inc said it was opening its first cash-and-carry center in India, a move seen as signaling renewed investor confidence in the government.

But the trade minister has since said he saw no need for further liberalization in retail, while a bill to raise FDI in insurance is languishing, and moves to raise foreign ownership in banks and open up the pension sector have also stalled.

There is no economic argument against modernization of retail; there is a political argument. And that is a concern about India, said Ira Kalish, director of global economics and consumer business at Deloitte Research.

And there are still substantial opportunities in other emerging markets like China, Brazil and Russia where either governments are more welcoming or consumer spend is high.

The value of Indian retail grew the least of the BRIC markets from 2003-08, according to research firm Euromonitor.

While Carrefour and Wal-Mart have continued expanding in China even through the downturn, Starbucks and IKEA have put their plans for India on ice, and Shoprite is ready to exit.

Until the Indian government frees up retail Shoprite, which has one wholesale outlet, would not be able to open more outlets to derive economies of scale, and its business cannot achieve breakeven results, it said in its annual report recently.

TORN

Some analysts say this does not augur a mass retailer exodus.

Look at Wal-Mart, Metro, Tesco -- they're all expanding, said Arvind Singhal, chairman of consultancy Technopak Advisors.

We tend to forget just how many foreign retailers are doing well in India, from Reebok and McDonald's to Louis Vuitton .

But while there is some support for opening up retail even within the government, it is unlikely to happen soon, said Montek Singh Ahluwalia, deputy chairman of the Planning Commission.

I think there is a case for relaxing that (FDI), but there's no proposal before the government at present to do so (and) I can't say it's bound to happen as of now, he told Reuters.

Still, recent reform in areas such as allowing retailers to procure directly from farmers, and moves to improve infrastructure, ease trade between states and introduce a simpler tax system have all cheered foreign retailers in the country.

Others including UK's John Lewis are keen to enter.

But they remain cautious about their prospects, Kalish said.

They are a bit torn: they see the opportunity, but there is some concern about making a go of it in India now, he said.

(Additional reporting by Alistair Scrutton; Editing by Ian Geoghegan)

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