AS THE WORLD LOOKS UP to India to be the engine of growth for the coming decade, showing the highest growth rate amongst G20 nations, for New India — consisting of the innovation economy of start-ups and investors, the budget expectation is two-fold.
The Indian stock markets demonstrated resilience during the global bloodbath. Global fund managers left their Indian positions as it was the only island of gains in a sea of despondence, allowing them to offset global losses. Indian indices could only show such resilience due to the "mutual fund moment" for Indian capital markets, which can be described as the convergence of factors — TEAM — that deepened retail participation in listed equities. It includes:
* Technology (Aadhaar, UPI for verification and frictionless investments)
* Economics (liquidity and favourable tax regime)
* Access (low ticket size, zero-cost brokerage)
* Market (falling stock prices, rising interest post Covid)
Contrasted with the annus mirabilis of 2021, 2022 was a painful U-turn, falling 35% year-on-year. There are many theories for this disparity in performance between India Inc. and Indian start-ups: Global tech rout, premium on profits due to rising interest rates, shrinking liquidity, etc., but one factor stands out — the minuscule role of rupee capital in Indian start-ups.
Rupee capital from domestic investors is barely 15% of the total capital raised by Indian start-ups. It's striated from being dominant in the early stage, where ticket sizes are low and risk is highest — to non-existent in the growth stage, where the deal quantum is smaller, but the size is large. Rupee capital is attracted to the riskiest part of a start-up's journey but is absent in the most rewarding stage — often bought out by global funds that dominate the late stage.
The primary reasons for this disparity in India's participation in innovation boil down to tax and regulation.
Taxes play a carrot-and-stick role in marshalling resources to desired areas of economic activity. Lower taxes and incentives indicate areas the government would like to grow and scale, while higher taxes dissuade activity. India's inertia in equalising the tax rate between listed and unlisted securities is baffling. Despite funding to start-ups going towards new asset creation, economic growth, and employment, it faces a tax rate and holding period twice that of the listed securities. This has been pointed out in the Economic Survey and by the Parliamentary Finance Committee in the past. The lack of action here has begun to starve Indian start-ups of capital as global funds fence-sit.
Similarly, Indian institutions such as insurance firms, foundations, pension funds, etc. face artificial friction in investing in private equity and venture funds. These restrictions prevent them from participating in Indian innovation. Rectifying this will allow rupee capital to become a participant as opposed to a passer-by of Indian innovation.
Despite efforts, domestic regulations are yet to reflect the operations of Indian start-ups and funds. Friction in making and receiving foreign payments, objective, and time-abound merger frameworks — in addition to tax factors, are cited as reasons for Indian entrepreneurs setting up shop overseas. Changes in corporate laws, forex laws, etc., are needed to attract and maintain Indian innovation in a digital world.
Funds, too, have suffered from the law of unintended consequences. Funds have been force fitted to vehicles that were never conceived of for fund operations. Due to this, judicial pronouncements have crippled funds in the past. Carried interest — an allocation of the gains from a fund by contract, has suffered due to this. Despite arising from the sale of securities, which are not subject to GST, tribunal ruling has stated that carried interest will attract GST.
Thomas Jefferson said that "laws belong to the living, not the dead". A rewrite of Indian laws to support Indian innovation is imperative for the country to deliver upon its promise. It needs to happen in India. Budget 2023 will be the decider.
Originally published in Fortune India