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Indian startups face a new normal amid China conflict

New FDI rules under close scrutiny as bilateral relationship deteriorates

TOKYO -- The dramatic rise in anti-China sentiment among the Indian public and leaders triggered by a border clash between two countries looks set to rewrite the financial playbook for Indian startups.

Fighting between the world's two most populous nations resulted in deaths for first time in 45 years. That set off a wage of anti-Chinese demonstrations in India and calls for boycotts of Chinese products. High-profile Indian startups, many of which rely on funding from Chinese investors, may also fall victim to the nationalistic backlash.

"Mega fundraising deals involving Chinese internet giants may no longer be a viable option for late-stage Indian startups," said a veteran venture capitalist based outside India.

In recent years, Chinese internet companies and venture capital funds have been a key part of the funding strategy for many new Indian companies hoping to become "unicorns," that is, unlisted startups valued at $1 billion or more.

According to Gateway House, Mumbai-based think tank, Chinese companies, funds and individuals invested $3.9 billion in about 90 Indian startups in 2019, up from $2 billion a year earlier. Indian startups, all told, raised $14.5 billion last year, the think tank has estimated.

Gateway House also reported in February that 13 of 26 Indian unicorns have shareholders in mainland China.

Indian unicorns with Chinese connections include such well-known names as Paytm, a mobile payments service backed by Alibaba Group Holding, and Ola, a ride-hailing company backed by Tencent Holdings.

The venture capitalist says many investors and entrepreneurs are waiting to see how the Indian government treats applications by Chinese to invest in domestic startups that were submitted before the latest border clash. "The results will tell the Indian government's basic policy on Chinese foreign direct investments in a period of higher geopolitical tension," he said.

The Indian government abruptly enforced in mid-April a new set of rules on foreign direct investment. These require regulatory approval for every equity investment in a domestic company by an investor from "a country which shares land border with India." The rules theoretically also apply to Bangladesh, Bhutan, Myanmar, Nepal and Pakistan, but they are obviously aimed at China.

The purpose of the measure is to prevent "opportunistic takeovers [or] acquisitions of Indian companies" that take advantage of depressed stock prices due to the COVID-19 pandemic, according to a circular released by the Ministry of Commerce and Industry on April 18.

The Chinese government reacted quickly, saying the move violated a consensus statement by Group of 20 leaders. Those leaders, including Indian Prime Minister Narendra Modi, held an online summit meeting in late March and agreed "to realize a free, fair, nondiscriminatory, transparent, predictable and stable trade and investment environment, and to keep our markets open."

The border skirmish between Indian and Chinese soldiers flared up in early May. In mid-June, a bloody brawl fought with clubs and stones resulted in the deaths of at least 20 Indian soldiers, sparking outrage in India. Twitter and WhatsApp were flooded with #BoycottChina posts. Protesters began burning Chinese products and effigies of Chinese President Xi Jinping in the streets.

Many social media posts criticized Indian TV news programs reporting on soldiers who died for accepting sponsorships from Chinese companies such as smartphone makers Xiaomi and Vivo. Some even criticized programs sponsored by Paytm and Ola, as they are backed by Chinese investors.

A China-based venture capitalist told the Nikkei Asian Review that so far his investment activities with Indian startups have not been directly affected by the souring ties between India and China. An executive at a Chinese-funded Indian unicorn said his company has not suffered direct damage from worsening public sentiment and is not worried about its funding prospects.

While the Indian government has repeatedly denied that it is trying to discourage Chinese investment in India or trade with the country, there are huge uncertainties over the perception of Chinese money and products in India, as well as New Delhi's policy toward China. On Tuesday the two sides agreed to pull back from the disputed border area.

Executives at startups and venture-capital investors will by trying to figure out how the new funding environment and public opinion will look after a few months. In the meantime, there have been positive developments for some.

"I expect, going forward, valuations of smaller Indian startups to return to reasonable levels," said a venture capitalist based in Japan. He noted the possible retreat of Chinese money follows a more conservative stance taken by Japanese investor SoftBank Group.

Softbank's $100 billion Vision Fund often worked hand-in-hand with Chinese internet players in offering piles of cash to Indian unicorns, leading to inflated valuations. "Those activities had trickle-down effects on smaller deals," the venture capitalist said.

SoftBank appears to be pulling back on big bets in the wake of poor investments in U.S. ride-hailing service Uber Technologies and The We Company, parent of WeWork, which leases shared office space. A slowdown in money from China will cool things further.

"Early-stage, non-Chinese, non-Softbank VC funds like ours will have better chances for good deals in India," the venture capitalist said.

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