The 3Cs That Will Propel Growth

The Indian economy will be a global engine of economic growth. The gross domestic product (GDP) growth rate projected is twice the global average, with domestic consumption and investments being the twin driving forces. The clarion call to industry is to make India a developed nation by 2047. The key to this transition lies in innovation.

Innovation ecosystems the world over are united by three strong factors: consumption, community and capital.

India’s growth path is contingent on the convergence of these factors.

Consumption

The figure of $2,000 per capita GDP is an inflection point for any economy, wherein there is a shift from subsistence consumption to discretionary consumption. India hit this point in 2018–19. India’s demographic dividend is paying off due to its investment in structural changes to the economy, such as: 

• Cheap data availability 
• Penetration of smartphones 
• Jan Dhan bank accounts and United Payments Interface (UPI) 
• Digitisation of services 

Barometers on Indian consumption like Zomato now command a valuation well in excess of banks, manufacturing companies and the like. The Indian private final consumption expenditure (PFCE) is 58% of India’s GDP, above China’s 38%. Cultivating domestic consumption while increasing exports will keep India in a unique position of atmanirbharta or self-reliance, as compared to China. 

Community

Community is a catch-all term that covers talent and networks. It includes education, human capital potential and support systems for an economy.

In terms of human capital potential, the best exemplar of this is the ever-growing representation of Indian origin chief executives of Fortune 500 companies. Our largest exports are not software services but software professionals. Over 1 million software engineers in the US are Indian. A study of 500 US unicorns done by Stanford Graduate School of Business’ Ilya Strebulaev found that Indian-origin founders are the most widely represented immigrant group.

Patents filed in India, a proxy for innovation, grew to over 83,000 in 2022–23, an increase of 25.7% from the previous financial year. It must be noted that software cannot be patented in India, unlike the US. If allowed, these numbers would be substantially higher.

The educational institutes too are emphasising experiential learning and host incubation centres and Atal Tinkering Labs that support nascent innovation.

Capital

Capital is where India needs the most reforms, especially for deepening the rupee capital pool available for investments. India has been a capital-scarce nation, though some of the scarcity is driven by policy not practice.

The depth of rupee capital in India is best exemplified by the Indian stock market. The Indian capital markets always joked that a cough in the US will result in a cold in India. But a study of the Indian stock market data from January 2021 to April 2024 between domestic institutional investors (DIIs) and foreign institutional investors (FIIs) shows that DIIs have been net buyers for 31 out of 40 months.  

This is mainly due to the deepening of systematic investment plans (SIPs) amongst retail investors, which have risen to Rs 19,000 crore monthly as of April 2024. This March saw the number of demat accounts surge to 15 crore, up from 11.45 crore. 

However, the unlisted markets paint an entirely different picture. Indian start-up funding dipped 83% in 2023 compared to 2022. While this was a worldwide decline, there are several factors unique to India which exacerbated the situation. 

Angel tax being extended to foreign investors: Angel tax or Section 56(2)(viib) of the Income Tax Act converts capital investments in unlisted companies into revenue receipt, which is subject to tax at 25%. Introduced in 2012 as an anti-abuse measure, it began to be misapplied to start-ups from 2016 onwards. 

The only silver lining was that this only applied to investments from Indian residents, who make up less than 15% of the total capital raised by start-ups. The February 2023 extension to non-Indian investors sent shockwaves throughout the funding ecosystem. 

Taxing risk capital at a higher rate than its peers: India is unique in taxing investments in unlisted companies and start-ups at a higher rate than its listed peers. Investments in start-ups are primary infusions, i.e., the money is used by the start-up to build products, hire people and expand business. These are risky, illiquid investments which go into new asset creation.

The stock market moves money from the pocket of one investor to another and is remarkably liquid. Despite this, India taxes gains from start-ups investments at twice the rate than its listed market counterparts.

RBI’s bar on NBFCs and banks investing in AIFs: Last December, the RBI barred banks and non-banking financial companies (NBFCs) from investing in alternative investment funds (AIFs), if the bank or NBFC has exposure to the underlying portfolio companies of the AIF. Though meant to address evergreening of loans, extending this to equity investments as well has thrown a spanner in the AIF industry—the only institutional means of raising private capital in India for investments. 

Deepening rupee capital: The need of the hour for the incoming administration is to strengthen rupee capital participation through legislation. Sebastian Mallaby’s Power Law narrates how two changes to the US regulations allowed the money coming in their start-ups increase over 22x from the late ’70s to the early ’80s: lowering capital gains for investments in start-ups and giving greater latitude to domestic capital pools to invest in start-ups. 

Similarly, India needs to reform its regulation to allow start-ups to contribute $1 trillion to India’s $5-trillion goal:

• Rationalise taxes between listed and unlisted companies 
• Allow Indian institutions to invest in AIFs and start-ups 
• Allow for wider variety of capital instruments 
• Allow principles of contract to govern private deals 
• Augment enforcement of contracts 

Only India can make itself a developed nation by 2047; but that means only India can prevent this tryst with destiny. This makes our future as diverse as our country; but India’s strength has always lied in its diversity. 

Siddarth Pai is Managing Partner, 3one4 Capital