India’s startup ecosystem set to adapt to tough financial conditions

0

India has become the third largest startup ecosystem in the world, with 107 unicorns (startups with valuations of $1 billion or more) with a total valuation of $340.79 billion, as of September 7, 2022. year 2021 saw a record 44 admissions. at the coveted unicorn club, even as many “soonicornes” (soon to be unicorns) lined up. India’s promising startup ecosystem, however, faces serious challenges attributable in part to current global macroeconomic conditions.

One indicator of this challenge is the sharp decline in funding available to Indian startups in 2022. Funding data from Inc. 42 and Traxcn reveal that, unlike the $4.6 billion in funding received in January 2022, Indian startups appear to be facing an early winter. , with only $885 million in funding received in August 2022. Similarly, looking at quarterly data, quarterly Indian startup funding peaked in the third quarter of 2021 at $14.8 billion, and has been steadily rising. decline since then. Seed funding numbers in the first and second quarters of 2022 were $10.3 billion and $6.84 billion, respectively. What explains such volatility in funding and this decline in available funding?

The reason for such a “funding winter” must be attributed to global macroeconomic developments, in particular the evolution of interest rate regimes between 2020 and 2022. When the pandemic hit, several central banks and in particular the US Federal Reserve, in a bid to control the worst effects of the pandemic, followed accommodative monetary policies to ensure the flow of credit in the economy. These policies involved the use of conventional and unconventional monetary policy instruments. Thus, the US Fed lowered the benchmark federal funds rate to historically low levels of around 0 to 0.25%. This action was meant to serve as a signal for further short-term rates to be lowered, with such low interest rates expected to stimulate spending by lowering the cost of borrowing for households and businesses. The Fed has also provided forward guidance on the future path of interest rates in successive statements from the Federal Open Market Committee (FOMC) throughout 2020 (bit.ly/3RMSqr3), indicating that it would keep interest rates on hold. interest close to zero.

The stated goal was to achieve a maximum employment and inflation rate of 2% over the long term, and the FOMC said it would maintain accommodative monetary policy until the announced results are achieved. The Fed also began to make large purchases of US government securities and mortgage-backed securities, and in June 2020 the Fed announced that it would buy at least $80 billion per month in Treasuries and $40 billion in residential and commercial mortgage-backed securities until further notice. It has sought to support households, employers, financial market participants, and state and local governments through massive lending.

The result of this unprecedented accommodation and low interest rates has been negative real interest rates in global bond markets. Investors, who were looking for real returns and growth, shifted their focus to holding public and private stocks, instead of previously held bonds. As a result, despite a sharp contraction in global gross domestic product (GDP), equity valuations rose across the globe, including in India. India received equity portfolio net flows of over $4.4 billion, even as debt portfolio flows fell to over -$3.3 billion.

With the U.S. Fed already raising interest rates four times in 2022 and also scaling back its quantitative easing and other measures taken to deal with the pandemic, and the resulting squeeze on liquidity, we can expect a return from stocks to bonds. This has led to a withdrawal of $26 billion from domestic markets (especially equities) by foreign investors since January 2022, and the rupiah has consequently depreciated by almost 7% between January and September 2022. The Reserve Bank of India (RBI) too, in turn, raised interest rates three times this year to deal with soaring inflation, while changing the stance of its monetary policy from “accommodative to a relatively warmongering policy.

What do these macro developments mean for Indian startups? As interest rates rise, and with the present value calculated by the formula [Present Value=Future Cash Flows/ (1+ interest Rate)^number of time periods]these increases would depress the valuations of the startups, even if they were not exposed to debt and had used equity to finance their operations.

Rupee depreciation would also impact both startups trying to raise funds in dollars and those that have already borrowed in dollars. In the case of the former, the depreciation of the rupee affects their financing as well as their valuations in the process. For those who have already taken out loans in dollars, their debts would become more expensive due to the depreciation of the rupee. These startups may not be able to use the complex hedging strategies used by larger companies. The depreciation of the Indian currency is also likely to increase the operational costs of several startups, negatively affecting their margins.

This year’s change in the global macroeconomic scenario means a change in the investment climate for Indian startups. The inversion of liquidity in the system and the depreciation of the rupee will lead venture capitalists to favor profitability and the unitary economy rather than growth. Companies with lower valuations and for which raising funds at lower valuations is less attractive will need to find sources other than equity financing. Preserving cash rather than consuming cash may therefore be the mantra to follow amid such financial uncertainty.

These are the personal opinions of the author.

Tulsi Jayakumar is Professor of Economics and Executive Director, Center for Family Business & Entrepreneurship, SPJIMR of Bhavan

Catch all the trade news, market news, breaking news and latest updates on Live Mint. Download the Mint News app to get daily market updates.

More less

To subscribe to Mint Bulletins

* Enter a valid email

* Thank you for subscribing to our newsletter.

Post your comment

Share.

Comments are closed.