Exchange Rate, Excess Returns In Equity Market Impact Startup Funding: RBI

Startup funding in India is impacted by three factors–level of economic activities, excess returns in the country’s equity market over the global benchmark and fluctuations in the exchange rate, according to The Reserve Bank of India’s bulletin.

A paper ‘What Drives Startup Fundraising in India?’ in the RBI’s bulletin states that in the long run, the excess return in the Indian bourses over the US stock market is a significant factor that impacts startup funding in the country.

“Startup fundraising is also influenced by the level of GDP (current prices) while it is hampered by the yield on the 91-day Indian and US treasury bills (the risk-free rate of return). Therefore, startup funding displays complementarity with equities but competes with debt,” the bulletin mentioned.  

Currency exchange rate depreciation is an element that has a negative impact on startup funding. Originally, a startup investment appreciates an investor’s equity stake while at the time of exit, the exchange rate depreciation reduces the sum obtained by the foreign investors.

“The inclusion of exchange rate in the model amplifies the GDP effect, undermines the effect of comparative equities performance and deems the impact of benchmark bond yields statistically insignificant,” RBI shared in its bulletin. 

Owing to this, in India’s open economy, fundamental economic performance is a crucial driver of startup investment and is supported by well-performing equities markets.

Meanwhile, in the short run, inflation rates, excess return between India and the US on small and mid-cap indices, the rate of federal funds, the central bank’s repo rate, and the economic policy uncertainty index are some other drivers impacting startup funding. 

Citing to the Department for Promotion of Industry and Internal Trade (DPIIT) data, the paper stated that a total of 87,988 recognised startups are working in the country as of July 19,2022.

“Startup dynamism is pervasive across sectors including IT services (12%), healthcare and life sciences (9%), education (7%), professional and commercial services (5%) and agriculture (%), according to PIB 2022 data,” the paper said.

The paper shared that as of September 2022, 107 unicorns were produced taking an aggregate valuation to $341 Bn. The highest number of unicorns are coming from the top three cities–Bengaluru, Gurugram and Mumbai, while fintech, ecommerce and SaaS startups are abundantly present in the country’s unicorn club. 

However, according to Inc42 unicorn tracker, India has minted 108 unicorns so far, cumulatively raising over $94 Bn funding at an aggregate valuation of $345 Bn. 

Besides that, Bengaluru, Delhi NCR and Mumbai produced the highest number of unicorns and meanwhile, most of the startup-turned-unicorns worked in enterprisetech, fintech and logistics sectors in the yesteryear, as per the Inc42 funding report 2022.  

Talking about fundraising rounds, the RBI’s bulletin stated that startups founded in recent years (2021 and beyond) are able to raise funding faster than startups established in 2014. 

“Intriguingly, startups founded recently are able to move up the funding ladder faster, with the median number of months between all stages shrinking drastically between those founded in 2014 and those in 2021,” RBI said in its bulletin.

Notably, the startup ecosystem is going through a market correction. Owing to this, Indian startups are facing difficulties in raising investments and resorting to cost-cutting measures such as trimming down their expenses, laying off employees and adopting cost-effective sales strategy. 

According to Inc42 analysis, over 20,000 employees have been laid off by Indian startups and unicorns including BYJU’S, Unacademy, FreshWorks and Vedantu, among others from January 2022 to till now.

At the same time, as per Inc42 funding report 2022, investors seem bullish about the startup ecosystem and have announced or launched 126 funds in aggregate in the previous year (2022). These funds cumulatively raised $18.3 Bn to back startups, particularly early-stage and growth-stage startups.