UPDATE 2-India investigates Wal-Mart over stake in local unit

NEW DELHI, Nov 16 (Reuters) - Indian authorities are

investigating claims that Wal-Mart Stores Inc. violated

foreign exchange rules when it invested $100 million in a

domestic unit owned by its wholesale joint-venture partner, a

law enforcement official said.

An Indian lawmaker first raised the allegations in a letter

to the prime minister in early September, and the complaint was

subsequently passed from one government department to another

without action being taken.

Wal-Mart, the world's largest retailer, has denied any

wrongdoing. The allegations relate to the company's complex

investment through debentures -- which could later be converted

to an equity stake -- at a time when direct ownership by foreign

firms was prohibited.

"Yes, the Enforcement Directorate has initiated an

investigation into the allegations against Wal-Mart," a senior

official, who declined to be named, told Reuters on Friday.

The Enforcement Directorate, an elite agency that falls

under the finance ministry, investigates financial crimes.

"The probe is at an early stage and therefore (it is)

difficult to say what the outcome will be," the official said.

News of the investigation comes at a bad time for the

Congress Party-led minority government, which is preparing to do

battle with opponents in parliament next week over its decision

to allow foreign companies into India's retail sector. The

furore could derail parliamentary proceedings.

Parties opposed to the new retail policy, which include some

government allies, may use the investigation to fan suspicion

among supporters against foreign retailers including Wal-Mart

whose entry is seen threatening the livelihoods of local

mom-and-pop store owners.

Arkansas-based Wal-Mart has repeatedly denied the

allegations.

"The central government has sought certain information and

clarification, which has been provided by us. We are not in a

position to offer further comments as the matter is before the

courts," a Wal-Mart spokesman said on Friday.

India liberalised its retail sector in mid-September to

allow global superstores to buy stakes in Indian companies - one

of a number of big-ticket reforms passed in September by Prime

Minister Manmohan Singh to revive a sluggish economy.

Previously, foreign retailers were only allowed to invest in

wholesale operations.

HEADACHE FOR WORLD'S LARGEST RETAILER

Wal-Mart was the most vocal advocate for the change and has

said it expects to open its first retail store within 18 months.

M.P. Achuthan, a member of the Communist Party of India that

opposes foreign direct investment in retail, accused Wal-Mart of

investing $100 million as early as early 2010 in a multibrand

retail business.

In September, Achuthan raised the issue in parliament,

questioning Wal-Mart's role in Easyday stores, which are

controlled by Bharti Enterprises, its partner in a wholesale

joint venture.

India's commerce minister answered that Wal-Mart, via its

Mauritius arm, held debentures that are convertible into a 49

percent equity stake in Cedar Support Services, the company

previously known as Bharti Retail Holdings that holds Easyday.

The law enforcement official confirmed that the Enforcement

Directorate was looking at Cedar.

"The main part of this investigation will be whether they

(Wal-Mart) offered a credit line. They have not made an equity

investment directly, but even if they offered a credit line, you

cannot do that," said Harminder Sahani, managing director at

Wazir Advisors, a retail consultancy.

Wal-Mart's Indian partner, Bharti Enterprises, has also

denied the allegation.

"We are in complete compliance of all regulations. All

details have been shared with the relevant authorities," a

Bharti Enterprises spokesman said.

The news came a day after Wal-Mart reported disappointing

quarterly sales and as it announced internal inquiries or

investigations into bribery allegations in Brazil, China and

India - additions to its original probe in Mexico.

The Indian law enforcement official said the probe was being

carried out under the Foreign Exchange Management Act (FEMA),

which regulates domestic currency markets, including foreign

direct investments and capital transactions.

The official said the agency had asked for documents on

Wal-Mart's operations in India from the RBI and the Foreign

Investment Promotion Board (FIPB), which clears foreign

investment proposals.

"The way company affairs work in India, very little is seen

as a criminal offense. So even if there are some violations,

companies are usually asked to pay a penalty and they are

allowed to carry on with their business," said

Sahani of Wazir Advisors.

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