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This was a 2,500-word feature for AVCJ focusing on rising Sino-India tensions and their impact on the Indian venture capital and internet technology ecosystem.

Historically a neutral power, India appears to be siding with the US in a multi-faceted war with China. This could have far-reaching consequences for VC investors and the technology ecosystem

Over the decades, Indian foreign policy has espoused a policy of non-alignment in international affairs across administrations. Prime Minister Narendra Modi has applied this in practice as he regularly seeks to establish a friendly relationship with world leaders of every ilk. Ten months back, Modi invited Chinese President Xi Jinping to an informal two-day summit just weeks after visiting US President Donald Trump in Houston.

What started out as a dispute on the parity of international trade flows between the US and China, however, has now pulled India into the dogfight not necessarily by choice. A high-altitude clash in June at a disputed area along the India-China border that led to the death of 20 Indian soldiers shocked a nation already scarred from the economic shock of COVID-19. While Modi refrained from directly criticizing Xi – he initially claimed China had not encroached on Indian soil much to the displeasure of his detractors – the incident forced Indian policymakers to abandon their friendly outlook on China.

Clearly outmatched on the military front, India took an unexpected snipe at Chinese internet technology by banning 59 apps owned by Chinese companies, most notably TikTok, citing data security concerns. It has inspired similar measures in the US. “It was a great way to apply pressure in a space that matters to the Chinese investor and technology community given that India is a prominent marketplace for products and a promising investment destination,” says Amit Narayan, an India-based partner at Control Risks, a specialist global risk consultancy. “I have no doubt that the intent to put pressure on China will continue for a while.”

Already upset by China’s close economic relationship with Pakistan, which many Indians claim offers base to terrorists, and harboring lingering resentment from a 1962 war that India claims was unprovoked, Sinophobia has come to the fore. There have been increased bureaucratic hurdles, cancellations of government tenders, a review of Chinese investments in the country, queries seeking to discover potential censorship of anti-Chinese content by apps, and higher tariffs on a host of imports from China.

The Indian government has also launched “Aatmanirbhar” or “self-reliant India,” a rhetoric-laden yet premature import substitution campaign that seeks to wean the country off Chinese-made goods.

Friend, not foe

On the other hand, Indian venture capitalists have a more balanced attitude towards their Chinese peers. Apps owned by Chinese companies or those significantly backed by VC investors rarely conflict with their portfolio companies anyway. Instead, Chinese investors – financial and strategic – were seen as a welcome addition to India’s growing stable of capital providers. They were especially of use to cash-burning consumer internet players.

Moreover, support from a Chinese investor was regarded as a kind of validation, given that investor’s experience of an earlier start-up boom. Last year, Chinese parties took part in PE deals totaling $6.9 billion in India. They rarely sought significant stakes, aware as they were of the political sensitivities involved.

Back in April, a regulatory update requiring mandatory government approval of Chinese investments unexpectedly targeted them. The action was taken in response to criticism from an opposition politician for an innocuous public market deal by China’s central bank, with the government maintaining that Chinese investors can participate in the growth of India’s technology sector. They just have to abide by new rules. Chinese VCs and strategic investors have since gone quiet, worrying industry watchers.

“I don’t think Indian venture capital can sufficiently replace Chinese investment,” says Sanjeev Krishan, a partner at PwC. “It may open the door for start-ups to court Western investors but most of them favor mature businesses. They like to sprinkle their financial bullets.”

An Indian VC manager currently fundraising observes there is interest from investors in Europe and the Middle East but it is still too early to tell if they will join a roster of familiar names from North Asia and the US. Anyway, COVID-19 has created a climate of uncertainty, complicating decisions to change emerging markets allocations for most investors.

In the long run, however, investors anticipate that increased digitization of staid sectors and the  exponential growth in user activity witnessed by many start-ups in a country where it will take months for life to get back to normal means they will get capital if they have a clear use for it.

“Good companies never die of starvation, but they could die of indigestion,” comments Sanjay Swamy, a managing partner at Prime Ventures Partners. “Every market in India needs to be digitized – we have companies doing this for intercity trucking and gated communities.”

He believes the Indian government will also be more nuanced about its approach to Chinese  investment in time. Thresholds for deals that require government approval are likely to be clearly defined, while in many industries data security concerns are meaningless.

Jio politics?

The border conflict also occurred after India’s start-up ecosystem received a huge boost in the form of INR1.5 trillion ($20 billion) of capital commitments for Jio Platforms, the holding company for telecom and internet assets owned by Reliance Industries. Facebook and Google accounted for more than half of this, with global GPs and sovereign funds contributing the rest. In a matter of weeks, it created India’s largest start-up.

Some analysts speculate the deals might have been influenced by US foreign policy and the desire to position India as an ally. The US technology giants and private equity investors could be looking to grab a foothold before major decisions are announced that signal even closer collaboration between the two large democracies.

“India as a country can be some kind of a counterpoint to China in this part of the world,” says Nitish Poddar, a partner and national head of private equity at KPMG India. “India and the US have always enjoyed a good relationship whether it was a Republican or Democrat administration. If the US wants China to be in check and it doesn’t have friends in India, then it can’t grow its influence in Asia.”

Meanwhile, Sanjay Kukreja, a managing partner at ChrysCapital Partners, offers a more prosaic explanation: It was simply a case of investors looking to put capital to work in a large-ticket deal at a time when it was fast becoming clear that private equity deal-making would be muted in 2020.

Jio Platforms plans to further increase access to affordable internet by offering low-cost broadband and telecom services and developing apps that increase their appeal. It will also invest in creating a nationwide e-commerce network. There is an agreement with Google to manufacture low-cost smart phones as well. The goal is to bring 350 million Indians who still use basic phones without touchscreens into the modern internet era.

“A lot of this capital will help roll out internet infrastructure at the size and scale that will play out well for the country in the long term,” adds Kukreja. “There could be a blurring of the lines – the oldworld consumer will finally be reachable by digital companies.”

Like a rising tide that lifts all boats, it is assumed Jio Platforms will look to acquire many start-ups, facilitating exits for VC investors. The company has made no secret of its desire to create a powerful ecosystem of apps under the “MyJio” – Hindi for “My Life” – banner for first-time internet users that are usually subscribers of Jio, the telecom service.

Indian media reports indicate that Reliance Industries, the oil-to-retail parent of Jio Platforms, is also in talks with ByteDance to see if it can acquire TikTok’s Indian operations.

As Google’s $4.5 billion commitment to the company came out of a newly launched $10 billion India digitization fund, there are clearly a lot more checks waiting to be signed. Others could follow the trailblazers.

“With that much capital coming in, every large pocket of capital in the US who hadn’t thought about India will stand up and take notice,” says one local growth stage investor. “They will say,’ ‘There’s something happening in India… why am I not spending time there?’”

Muted outlook

Regardless of any geopolitical agendas, these investments are contingent on monetization, specifically the ability and willingness of Indian consumers to pay for services. Much rests on how the country deals with COVID-19.

As of mid-August, total infections since the start of the pandemic exceeded 2.7 million – behind only the US and Brazil – with 52,000 fatalities. City streets usually characterized by boisterous activity have turned eerily silent in recent months. Businesses remain shuttered while public transport has ground to a halt as strict quarantine measures across states deter what little inter-state travel is being attempted.

People who can work from home continue to do so. Those who are required on-site are taking necessary precautions. Meanwhile, massive layoffs in the informal sector and the return of thousands of migrant workers from overseas imply millions of Indians will be unemployed for the coming months. Everyone agrees that the epidemic has severely dented consumer confidence for the near term.

However, a closer look at the underlying numbers offers some hope. India’s population is larger than that of the US and Brazil, while its infrastructure is less substantial, but the mortality rate is 13 times lower. “The fatality rate has been very, very low,” says Sateesh Andra, a managing director at Endiya Partners, a health tech-focused VC firm. “Nobody knows if it’s because of our genes or because of a particular mutation of the virus. The worst appears to be behind us.”

Exhorted by Modi to live with the virus, India is getting back to work. The recovery is happening at different paces at different locations based on the intensity of local outbreaks, but predictions of catastrophe have largely missed the mark.

“We are all reconciled to India’s economy taking a massive hit,” says Control Risks’ Narayanan. “It could be as much as a 10% decline in the real economy. At the same time, India’s digital economy will grow faster and sooner simply because so much of consumption is moving online.”

Given the formal working class that usually resides in urban areas is a key consumer group, effective remote working measures have ensured they remain financially healthy. As similar trends play out around the world, it has created opportunities for Indian IT services companies to develop their enterprise offerings.

“India never used to have large software-as-a-service (SaaS) start-ups,” says Atul Mehra, a partner at EY India. “Postman [a collaboration platform for API developers] achieved a $2 billion valuation recently, joining Freshworks as a unicorn. There is also healthy investment in Indian data infrastructure from private equity and technology giants alike.”

Hardware dreams

It is too early to say whether the country can add hardware to its software competencies – a clear objective under the “self-reliant India” agenda – despite a general move among multinationals to reshore supply chains that are heavily reliant on China.

The government’s stated desire for a nuts-and-bolts technology sector has been backed up by various policy initiatives, including the relaxation of labor regulations and production-linked subsidies, However, a plethora of problems that have long continued to deter global corporations.

“There is the pentagram of Indian issues – land, labor, capital, infrastructure and taxes,” says Narayanan of Control Risks. “Add to that sector-specific regulation, growing data localization requirements and state-level risk.”

Nevertheless, supply chain diversification efforts could see India win a second chance with multinationals. The country lost out on the first wave – triggered by rising labor costs in China – because the likes of Vietnam were deemed to have a more stable policy environment. Private equity firms are also tracking evolving geopolitical risks and considering the implications for their portfolio companies.

“China is not a final market for our portfolio companies, it’s a source of inputs,” says ChrysCapital’s Kukreja. “I think there will be people who will capitalize on the whole import substitution goal and it’s an opportunity for Indian entrepreneurs.”

Conversations have begun but large corporations will not rush into decisions on manufacturing destinations. At present, India does not have the same purchasing power as China to support expansion plans, but time might be on its side.

“Foxconn has already started manufacturing the latest Apple models in India,” points out KPMG’s Poddar. “There are at least 10 different Japanese companies talking to us about setting up sourcing arrangements in India, either organically or inorganically. It’s happening but the impact will only really be felt over a 5-10-year period because these are long-term strategic investors.”

Exit angst

Ultimately, for investors assessing the potential of India’s technology sector – as an LP, GP or a strategic player with a balance sheet money – exits trump all other concerns. Indian companies can make smart phones and develop software that works on them, and local  consumers might be willing buyers, but this commercial activity must crystalize into distributions.

An enduring problem for Indian start-ups is the lack of a reliable path to liquidity via public markets. Trade sales continue to dominate. “While the exit landscape has expanded and diversified significantly in recent years, the market has not been extensively tested yet for large exits, or for large PE-backed IPOs,” says Frank Su, head of Asia private equity at Canada Pension Plan Investment Board (CPPIB).

The industry drew succor from the recent $300 million all-cash acquisition of WhiteHat Jr, an 18-month-old online coding school, by local education player Byju’s, which facilitated exits for several VC investors. However, such deals are few and far between; all-stock acquisitions, which might offer no near-term liquidity event, are much more common.

Meanwhile, the prospect of IPOs on NASDAQ has long been mooted and this year came a little closer to fruition. The Securities & Exchange Board of India has signaled a willingness to explore the possibility of revising rules that currently require Indian companies to  complete a domestic listing before listing overseas.

“Rumors in the market indicate Jio Platforms could lead the way but the bar at NASDAQ is pretty high,” says one growth equity investor.  “A NASDAQ listing is for people who have private investors chasing them. Apart from Jio Platforms, I’m not sure if most Indian start-ups qualify.”

Jio Platforms has clearly captured the imagination of India across multiple vectors. Not only will its war-chest lead to significant acquisitions, there is a hope it could inspire a new generation of entrepreneurs to leverage a transformed internet landscape. “When you see such a massive level of investment, it will lead to state-of-the-art expertise and innovation coming to India,” says Prime Ventures’ Swamy.

And this is where the US-China angle swings back into view. It is claimed that Google decided to double down on India by investing in Jio because the country had proved itself as a testbed for technology solutions in emerging markets – Google Pay, formerly known as Tez, was first developed here.

“You can’t copy and paste what works in developed markets in India, but you can do the reverse,” Swamy adds. “Jio Platforms is unique but it’s not the only one. There are several diamonds in the rough out there.”

Putting Indian start-ups in a position where they can think about accessing developed markets, and build strategic relationships with large corporate partners, will likely require the return of Chinese capital. For that, relations must thaw between US, China and India.

An online version of the article can be found here. This article featured in the August 18 edition of the Asian Venture Capital Journal released a week before the annual AVCJ India Forum.