Red carpet

In a quiet move that could have just as much impact on capital flows into India as the earlier announcements on Foreign Direct Investment, the Centre has recently announced sweeping relaxations in its regulatory regime for alternative investment funds (AIFs), infrastructure investment trusts (InvITs) and real estate investment trusts (REITs). Investments by foreign investors, including non-resident Indians, into these vehicles will no longer require FIPB approval. This relaxation should allow PE/VC funds, infrastructure funds and REITs with an India exposure to tap into a much larger pool of global risk capital, without procedural delays. AIFs and other investment vehicles, if controlled or managed by Indian sponsors, will not be subject to sectoral caps on FDI or other restrictions with respect to their own portfolios. This is significant as bypassing sectoral FDI caps can prompt a sizeable number of foreign investors to take the AIF route to explore promising sunrise sectors, be it multi-brand retail, e-commerce or even microfinance. Clear definitions have also been put in place on what would constitute India-sponsored AIFs. While this may help resolve some vexatious procedural issues plaguing these investors, some clarity on aspects of taxation, such as the applicability of withholding tax to exempt investors, is required.

Overall, the changes signal a recognition that India’s startup ecosystem, unlike India Inc, is thriving, and is in active risk-taking mode. Indeed, it is the emergence of innovative business ideas in sectors such as technology, internet and e-commerce that has ensured a $7-10 billion influx of capital via the PE/VC route over each of the last seven years, even as both foreign portfolio flows and FDI have faltered. This trend certainly merits encouragement, given that PE/VC firms tend to take a more long-term view of their investments (typically 5-7 years) than portfolio investors. Moreover, they actively participate in the management of local firms to drive scale, profitability and better governance. But while higher inflows may now seek out startups in the fancied tech, e-commerce or consumer sectors, it would be wrong to believe that this will throw a lifeline to distressed firms in ailing sectors such as infrastructure, retail or real estate. After all, AIFs, REITs and InvITs are patronised only by highly informed investors, who are primarily driven by business and return considerations.

With these relaxations, the Centre has taken its first steps towards its ‘Start Up India, Stand Up India’ initiative. In his Independence Day address, the Prime Minister had also hinted at other ideas to encourage startups — namely, direct government funding, easy bank loans and tax incentives. Those are inherently bad ideas; given the high failure rates of startups, it would be quite unfair to burden beleaguered Indian banks (and indirectly depositors) or taxpayers with the task of supplying risk capital to them. Hopefully, the Centre has now realised that the job of funding startups is best left to investors like AIFs, who exist mainly to take on these high-risk-high-return bets.

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