Dragon's Co-existence with 'Atmanirbharta'
Impact of FDI Revision on Indian Entrepreneurial Ecosystem
On June 29th, Paytm founder Vijay Shekhar Sharma said that the government's ban on 59 Chinese apps was a bold move and in the national interest.
Paytm, run by One97 Communications, counts China's Alibaba and Ant Financial as major investors. Alibaba and its affiliate entities own over 25 percent in One97 Communications, including Paytm Mall, Paytm Money, and its other units. Sharma's statement is also a far cry from previous years when he touted Alibaba and his relationship with its co-founder Jack Ma as his biggest strengths. Paraphrasing a popular Hindi movie line, he said in 2017,
Mere paas ma hai… Jack Ma
The recent ban on smartphone applications of Chinese origin and other trade restrictions which we talked about in our previous article when combined with a recent government order regarding FDI investments from our neighbouring countries poses a series of challenges for the Indian Startup Ecosystem.
‘Hindi Chini Bhai Bhai’?
Back in April 2020, it was reported that The People's Bank of China raised its stake in HDFC from 0.8% to 1.01% sometime between January and March of this year. Alarmed by this, the central government revised India's Foreign Direct Investment (FDI) policy. With respect to the revised FDI policy, investments from China will now require a clearance from the Centre.
The amendment to the FDI rule states,
A non-resident entity can invest in India, subject to the FDI Policy except in those sectors/activities which are prohibited. However, an entity of a country, which shares a land border with India or where the beneficial owner of investment into India is situated in or is a citizen of any such country, can invest only under the Government route.
This action was introduced through a note from the Department for Promotion of Industry and Internal Trade, which revised the foreign direct investment policy to curb opportunistic takeovers of Indian companies. Also, transfer of ownership of any existing or future FDI in an entity in India, directly or indirectly, resulting in beneficial ownership falling within this restriction will require government approval. The move follows concerns that China could take over Indian companies at a time when their valuation has taken a massive hit because of the economic crisis triggered by the pandemic that originated in Wuhan. Prior to this, all investments from Pakistan and Bangladesh required the government’s approval for security reasons. The scope of this existing policy has been widened to cover all neighbouring countries that share a border with India.
There is little doubt as to what the government’s intent through its action is. The concern is that Chinese capital — which is often linked very closely with the government in Beijing and the Chinese Communist Party — will seize the opportunity afforded by the pandemic to buy temporarily undervalued assets in India. This may have negative strategic implications, and thus such investment will have to be scrutinized to ensure that they are not linked to the government in Beijing or the Communist Party.
(Credits: Jack Ma/Twitter)
The trend of Chinese businesses making serious investments into Indian companies began in 2015 when e-commerce giant Alibaba made a handful of investments in companies such as Snapdeal and Paytm. Chinese tech investors have put an estimated $4 billion across over 90 Indian startups operating in various sectors, according to a February report by foreign policy think tank Gateway House, Indian Council on Global Relations. The extent of Chinese investment in the Indian startup ecosystem can be gauged by the fact that 18 of India’s 30 Unicorns (startups with a valuation of $1 Billion and above) had Chinese investors. This includes Unicorn’s such as Flipkart which was later on acquired by Walmart for $16 Billion in 2018 and the latest Unicorn startups as well such as Delhivery, Dream11, and Rivigo.
India's top startup unicorns - including Paytm, Zomato, BigBasket, and Dream11 - that count Chinese investors among their largest backers are likely to face delays in raising capital. A slew of growth and early-stage companies, too, which were in talks with Chinese investors for new investment rounds, will likely face difficulties, while follow-on rounds from existing backers may become increasingly complex to execute, according to investors, lawyers, and startup founders.
The Way Forward
The policy change in its current form would also require clarifications from the Government on two very crucial aspects. The first one being the absence of a certain Beneficial Ownership (BO) threshold which puts the investors and the dealmakers in a tough spot. The BO threshold is a key determinant in deciding whether FDI investment from countries that share land borders with India can come under the automatic route or if it requires government approval. Authorised dealer (AD) banks are applying different thresholds for determining BO for foreign direct investment coming into India. The threshold being applied ranges between 25 percent and 10 percent (to even 1 percent). A clarification from the government would not only not facilitate proper injunction of future investments but would also help fulfill commitments that haven’t been materialised yet.
Another aspect that requires clarification from the government is the definition of land borders when it comes to Chinese investments. One can assume that Hong Kong Special Autonomous Region is part of the freshly constrained areas but the same cannot be said about Taiwan and whether it is included in these rules or not.
(Credits: Narendra Modi/LinkedIn)
The current regulatory scenario and the ever-deteriorating Indo-China relationship would surely hamper the growth of the Indian Startup ecosystem which saw an influx of capital from Chinese firms. On the other hand, a devil’s advocate would state that the current situation arising out of the recent policy moves helps in making the entrepreneurial ecosystem more “atmanirbhar”. Prime Minister Narendra Modi on Saturday launched the Aatmanirbhar Innovation Challenge, inviting India’s tech and community to create an Aatmanirbhar App Ecosystem. “Today, when the entire nation is working towards creating an Aatmanirbhar Bharat, it is a good opportunity to give direction to their efforts, momentum to their hard-work and mentorship to their talent to evolve Apps which can satisfy our market as well as compete with the world.” PM Modi’s LinkedIn post said. Only time will tell if these protectionist reactions along with a push for local innovation will bear fruitful results or not.
Dilip Mishra is a B.Com (Hons.) graduate from the University of Delhi and has previously worked with S&P Global Market Intelligence as a Data Researcher.