Global Money Shifts to India as Xi Cracks Down on Tech

You would think Chinese President Xi Jinping is dead set on kneecapping his country’s much-vaunted tech industry, which makes up nearly 40 percent of China’s GDP. His government’s crackdown on some of China’s biggest internet companies has already wiped out $1.5 trillion in stock market value. This comes at a troubling time for the Chinese economy. Even as it is letting the air out of tech, Beijing must scramble to control the popping bubble in the country’s infamously inflated real estate sector. These problems are now compounded by an energy crisis that has led to power blackouts and could soon impact manufacturing.

How these cascading Chinese crises will affect markets elsewhere is still unclear, with one exception: Capital with fewer opportunities in China clearly needs a refuge, and some of that money has found one in neighboring India. But although this shift in global capital flows certainly isn’t good news for China, it may not be good news for India either. The problem: India is not yet ready to absorb vast new flows of hot capital. The result would likely be a tech bubble whose bursting would hurt a society hobbled by the ravages of the pandemic and persistent government mismanagement.

You can’t blame investors for growing leery of China. Ever since Beijing abruptly suspended the $34 billion initial public offering (IPO) of digital finance platform Ant Group last November, news about China’s tech crackdown has not let up. Beijing has declared cryptocurrencies illegal and imposed harsh new strictures on online private tutoring and video gaming. Tech companies also face sweeping industry-wide changes, from anti-monopoly legislation to new rules governing data collection and use. Regulators have taken a heavy hand to tech giants, calling on Ant Group to separate its payment and personal finance businesses, stopping ride-hailing company DiDi Chuxing from accepting new users, and levying a $1 billion fine on food delivery platform Meituan for anticompetitive behavior. Amid mounting pressure, the prominent founders of TikTok, JD.com, and Pinduoduo recently escaped into early retirement.

As a result, investors who had rushed into China have little option but to look elsewhere until the picture clears. One of those alternative destinations—especially for those wanting to diversify from the developed markets—has been India.

Perhaps the most rapid investor shift has taken place in venture capital. As the tech crackdown came to a head this summer, capital going to Chinese start-ups plummeted from $17.3 billion in June to $4.8 billion in July while during the same period, investments in Indian start-ups rose from $1.6 billion to nearly $8 billion. Although venture capital investments can bounce around from month to month, this dramatic shift was the first time since 2013 that the value of venture deals in India exceeded the value of those in China. The shift is even more impressive when one considers that Chinese start-up investments were around 10 times India’s during the first three months of 2021.

Consider, as well, the example of Tiger Global Management, a New York-based company that’s part private equity firm, part hedge fund. As of March 31, it held investments in about 36 private Chinese companies in addition to $8.6 billion in public ones—the highest exposure to Chinese companies among major U.S. hedge funds with publicly disclosed data. Tiger’s China portfolio has suffered significant losses, and the firm has been shifting capital toward India. In 2021, it has already invested in more than 25 Indian start-ups in finance, food, education, and social networks. Tiger is by no means alone; another widely watched investor, Japan’s SoftBank Group, has declared it halted new investments in China until the effects of the crackdown play out. At the same time, it expects to invest $4 billion in India by the end of this year, making it one of the biggest years for its investments in India. For yet another barometer, India is also far outstripping China in newly minted so-called unicorns, private companies valued at more than $1 billion. In public equities, India has been attracting investors as well: As of Friday, the BSE SENSEX is up 26 percent so far this year, while the CSI 300 Index—which tracks 300 large Chinese companies—is down 6 percent over the same period. All this represents a dramatic but little-noticed reversal of investor priorities from China’s bigger and faster-growing market to India’s, which has long been a less popular destination for foreign capital.

India has obvious attractions, of course. It is the world’s second largest digital market, with more than 900 million mobile phone users anticipated by 2023 among a population expected to exceed China’s by 2026. A major barrier in capitalizing its digital potential has long been the country’s addiction to cash, which even Indian Prime Minister Narendra Modi’s draconian demonetization in 2016 could not dislodge. The pandemic and life under lockdown have changed that. Digital payments have accelerated. In particular, use of the Unified Payments Interface mobile app, which integrates multiple bank accounts and allows for seamless digital payments, almost doubled from 12 billion to 22 billion transactions between April 2020 and 2021. In addition, the average time Indians spend on smartphones spiked to the highest in the world in 2020, according to a Nokia study. Data traffic in the country has grown around 60 times over the past five years.

This means in a very short time, the need to serve this digital population exploded, so the Chinese tech crackdown came at an opportune time. There is a vibrant entrepreneurial ecosystem in India’s major tech hubs, including Bengaluru and Mumbai. Our Digital Planet research has found that India has one of the deepest freelance talent pools in the world. What this ecosystem needed was the funding and connections that international investors—especially those in the venture capital space—can bring with them. The influx of capital fleeing China for India has produced many high-flying start-ups already. They include Innovaccer, which manages health care data online; Meesho, which helps Indians sell stuff on messaging apps; Razorpay, which enables online payments; and Chargebee, which manages online subscriptions.

But although these developments are exciting for India, there are reasons to worry about their sustainability. When it’s not investors looking for opportunity but hot money seeking refuge, we have the beginnings of a bubble. Early investors draw in others who fear they are missing out. More investors rush in, perpetuating the cycle. Cascading tranches of money overcapitalize start-ups, giving more money than what’s needed to get to necessary milestones. Each investor is pressed to overvalue a company to get in on the deal, far exceeding what is justifiable based on longer-term market fundamentals.

There are five reasons to worry about India’s longer-term market fundamentals and why it may not be the ideal destination international investors hope for.

First, Indian consumers—even those in the rapidly expanding middle class—are used to low prices. Although consumers can be drawn in with discounts, costs mount as companies try to scale up, making it hard to find a pathway to profitability. This is especially true when there are multiple competing start-ups in the same space, each egged on by multiple investors.

Second, investors need an exit so they can get a return on their money. In India, these exit pathways are unclear. Despite the much-hyped public flotation of food delivery start-up Zomato, the country lacks a track record of successful IPOs. Nor are there enough deep-pocketed large corporations that would pay to acquire many of these start-ups at their pumped-up valuations.

Third, India still suffers from numerous regulatory uncertainties. The rules change frequently, and the state is taking on a more activist role in regulating and constraining the tech industry. The Indian government has yet to enact a data protection law but insists user data be held locally. A recently promulgated set of rules governing information technology and digital media established additional onerous restrictions and requires compliance with content takedown requests by the government. Numerous petitions are already making their way through the courts challenging these rules. To add to the high degree of political risk, India ranks third, behind only Russia and China, in state surveillance of citizens, which could pose ethical challenges for many companies.

Fourth, many digital businesses, from e-commerce to delivery services to ride hailing, need physical infrastructure, which in India is still poor. The government’s uneven track record of managing the pandemic and its economic fallout is mainly due to the fact that public service infrastructure is so weak. Chronic underinvestment in public education, health care, and job market readiness undermines India’s talent pipeline. Despite the country’s youthful demographics, there is a shortage of human capital, which is only going to get worse in the absence of sustained long-term public investment.

Fifth, whether Indians’ new online habits will stick in a post-COVID-19 world is still up in the air, especially since face-to-face contact is so integral to the country’s social fabric. This means the current burst of demand may not last, let alone grow sufficiently over the longer term.

Although Indians are understandably heartened to see their tech start-ups finally getting their due, it is important to keep an eye out for irrational exuberance. Tech, as history has shown, is particularly prone to bubbles and subsequent collapses in sentiment. While tech bubbles may not automatically lead to ruinous outcomes (except for investors) and are arguably crucibles that forge the next generation of superstar companies, this logic may not apply to a country like India. India desperately needs patient capital, skilled talent, and appropriate technology to solve the country’s fundamental problems laid bare by the pandemic. The last thing the country needs is for all three to take flight, even temporarily, when a bubble bursts.

Xi’s harsh crackdown on tech in China ensures the music will be playing elsewhere—increasingly, in India. Given the inevitable boom-bust cycle in tech markets, it is essential for Indian policymakers to ensure there are enough chairs in the room when the music stops.