What does the Evergrande crisis mean for the Indian startup ecosystem

In 2008, when Lehman Brothers collapsed in the US, the world witnessed an of its kind financial meltdown in recent history. Cut to 2021, just after the world has been through the economic rollercoaster of the COVID-19 pandemic, China’s Evergrande is the next looming crisis that the market is seeing. 

Given the interconnected nature of economies and markets, the Evergrande crisis has significant implications for the Indian markets, and more specifically the Indian startup ecosystem. It is no secret that the Indian startup ecosystem is highly dependent on foreign capital and inflows.

Kumarpal Jain, Assistant Vice President, Fintso, a wealth-management platform, says, 

“Severe economic distress in China would also drive away investment capital from all of Asia. Furthermore, any significant pullback in Indian markets will tend to dry up local funding. Our base case, however, does not expect these scenarios.” 

Most believe as India moves towards middle-income status, support for the startup ecosystem is only going to accelerate.

India - the new darling 

“Further, given the uncertainty surrounding China, private market investors could increase their focus on India. The Evergrande situation followed months of uncertainty as emerging as well as established startups were impacted by the Chinese government’s policy changes,” says Viraj Nanda, CEO, Globalise, a global-wealth management platform. 

In Nanda’s opinion, India provides investors with an attractive alternative as it is the other emerging economy with growth characteristics similar to those in China. “Albeit with a more encouraging political and regulatory landscape,” he adds. 

So far, foreign investors, both LPs and general partners had a choice of two big markets - India and China. But the Chinese government and authorities haven’t had a positive outlook on the businesses. There have been actions taken against the ride hailing app - Didi, microblogging platform Weibo, Alibaba, and food delivery giant Meituan. 

These actions have made many investors wary of the Chinese market. The crackdown by the Chinese government has in fact given India a geo-political edge. Also, the Indian government is constantly supporting businesses in the post-pandemic scenario, and the improvement in the ease of doing business is a stated and constantly focused area from the government. 

In an earlier conversation with YourStory, Sreedhar Prasad, Advisor, Analyst, ex-KPMG, and ex-Kalaari Capital, said, 

“There is a very strong optimism in India, and it has never been like this before. India has become a trusted destination for foreign money. This is also another reason why there are so many unicorns in the market. There’s a lot of money in the market, which is not being invested -- whether it is venture money, family office money, or personal money. And this is sector agnostic.” 

This optimism is also seen in the boom of unicorns that India has seen. We already have 27 new Indian unicorns in 2021, and close to 61 active unicorns in total. 

The funds that were significantly investing in China and other markets are now looking at India. “Earlier, everyone would say tech is booming in India, but if you look at 2020, we realise everything is booming in India,” Sreedhar said.

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But what is the Evergrande Crisis? 

Before we dive deeper into Evergrande’s impact on Indian markets and the startup ecosystem, the context of the crisis merits explanation. While the Lehman Brothers reflected holes in the US financial sector, property giant Evergrande is representing those in China. 

For close to two decades, the Chinese economy and its financial sector has been boosted significantly by its real estate development sector. However, in recent years, the segment has become the epitome of unsustainable debt.  

Though it has been a cause for concern, there haven't been steps taken to hedge. Also, the old adage - too big to fail kept people going. 

Now, Evergrande is one of the largest real estate developers in China. It has more than $300 billion due to lenders of which repayments of $850 million are due in the next three months. What has changed now is that global credit rating agency Fitch Ratings has downgraded Evergrande along with other Chinese developers. A default by the real-estate giant can impact China’s real estate sector as a whole. 

In the midst of the Chinese crisis, there are indications that the US Federal Reserve would soon start its tapering–reduce its pace of large-scale assets’ buying. 

Nanda, of Globalise, points out that the Fed’s tapering decision would have multiple implications. Firstly, it would pave way for the eventual rise in interest rates. The rates have been hovering close to zero for a while. 

As rates rise, capital flow into the US from other developed markets are likely to increase as the yield becomes attractive. “This would happen at the expense of emerging markets,” Nanda warns. 

The US dollar is also likely to strengthen as rates rise. “While rising rates are not entirely bad for equities, some choppiness is likely to be experienced initially,” Nanda adds.

As Asheesh Chanda, Founder and CEO, Kristal, a wealth-management firm, says, “Firstly, when we look at Chinese credit, we are seeing spreads widen in pockets like short-term commercial paper, bond-linked structured deposits and overall high-yields, but it is still orderly.” 

Also, in Chanda’s view, high quality names have been immune till now to a large extent. “Having said that, it is fair to assume that if Evergrande does default, there is a high likelihood that Chinese high-yields will suffer and we could see contagion,” says Chanda.

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Implications for Indian investors 

Soumyo Sarkar, a member of wealth management platform Fintso Advisory Council, opines that the current set of developments would be highly beneficial to Indian investors. And, an Indian investor should consider putting 10 percent, or more of their equity investments, into the US markets.

Reason: Historically the US markets have significantly outperformed India over various investment horizons such as 3/5/10/20 years, when adjusted for Indian rupee (INR) depreciation. “US continues to be the innovation hub of the world and their world beating returns are expected to continue,” says Sarkar.

Jain of Fintso adds that up until now, the Chinese government crackdown and interference in the private sector has been a net benefit to India, in terms of directing more foreign direct invest (FDI) inflows into India. 

“Many funds have fixed pool of capital to be invested in Asia, and in 2019, around 40 percent of that capital went to China. Even a small shift there would mean a significant flow into India,” says Jain. 

However, the Evergrande situation is different and poses a negative threat to India. Jain explains that real estate plays an outsized role in China and it is estimated that an average Chinese person has 70 percent of his, or her, net worth tied up in that sector. 

“A severe deceleration in that industry, or worse, a debt explosion, could clobber the Chinese economy negatively and impact the rest of the world, particularly Asia. Our base assumption is that China, with all their control mechanisms, would be able to avoid a “Lehman” moment, in exchange for a period of slow growth,” says Jain. 

However, for investors from India who have exposure to Chinese equity equities, this can add increased volatility. Chinese equities have already been choppy in the wake of the government’s curbs on some of their top tech names. For investors with mostly US exposure, the Evergrande situation would have a negligible effect.

Anshul Gupta, Co-founder, Wint Wealth, a wealth management firm, explains, tapering can lead to potential volatility in currency, bond and equity markets. 

“We witnessed in 2013 how India got bucketed in the Fragile Five category,” says Gupta. However, this time India has a much deeper forex reserves war chest of over $638.6 billion as of September 24, 2021. This should give comfort to the global markets and hopefully help lower the volatility as and when the tapering starts,” Gupta adds.

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Implications for Indian startup ecosystem

The Indian startup ecosystem is largely a domestic affair. Most startups are positioning themselves to take advantage of the demographic tailwinds and expansion of the digital ecosystem and address the inefficiencies in the system. 

While global macro events can affect flows into Indian equities and debt, the early-stage funding from both domestic angels and global venture capital firms would continue to back startups.

The US is the largest equity market in the world, and accounts for over 50 percent of the global equity markets, by market capitalisation. India is less than three percent, in comparison. The US is also the most attractive market for foreign listings with European, Japanese and Chinese stocks trading there. 

The breadth and depth of the US market offer opportunities that are not available elsewhere. Finally, from a risk perspective, diversification of one’s portfolio reduces the overall risk, hence enhancing risk adjusted returns.

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