Cash in hand: India's demonetization policy

Private equity, especially in Asia, has always had what is best described as an interesting relationship with policy makers. New legislation, whether it is perceived positively or negatively, has an impact on the industry because of the illiquid nature of the typical PE portfolio. From sector deregulation, to state-owned enterprise reform, foreign ownership laws and tax treatment, governments have a proven track record in hindering - and helping - private equity investment and exit activity in many parts of Asia.

A recent example would be the Indian government's sudden decision to rid its economy of INR500 and INR1,000 banknotes. Since its November 8 announcement, this policy has raised more than a few eyebrows and prompted plenty negative reactions locally and internationally. As for private equity, the question is what kind of impact will demonetization of certain banknotes have on an industry that deals mostly in sums too large to be transacted in cash.

Speaking to an LP with exposure to a number of Indian private equity funds, the belief is that demonetization will largely be a good thing for the fund managers because it will remove black money from the economy. Much like a detoxification process, there will be some pain before the situation gets better, with portfolio growth likely to take a hit over the next two or three quarters as companies face a cash crunch. "Market-to-market valuations will be down, public markets are down, multiples are down, and liquidity will slow down," was the LP's assessment.

This is not helpful for GPs looking to launch new funds: an existing portfolio that might already have come through some difficulties will erode in value, while any impending exits might be postponed or even called off. From a longer-term perspective, though, private equity stands to gain. First, it forces companies to be more transparent about their finances, which contributes to good governance and makes for more attractive investment targets. Second, it drains power from unofficial sources of financing - where a lot of this black money likely accumulated - and makes companies more amenable to approaches from mainstream capital providers.

For those with dry powder, demonetization is already creating opportunities. Venture capital firms that have been banking on the recent rise of financial technology, especially online payment providers, will likely see increased business for their portfolio companies as well as renewed interest from other investors. As many recent reports have highlighted, these cashless payment companies have seen a proliferation in potential customers, as small vendors who would have previously relied almost entirely on cash-based transaction reconsider their options.

Coincidentally, the AVCJ India Forum features a panel with senior representatives from Paypal, Freecharge and Mobikwik, who will no doubt discuss the issues, opportunities and challenges presented by the changing regulatory landscape.

The Indian demonetization is only one of many policy-related incidents that are going to affect private equity in the near future - and some will have a more direct impact than others. As the industry continues to mature, governments are paying more attention to the role played by private capital in local companies and the broader ramifications for the their economies. Particularly as a result of the disruptive influence of mobile-based technologies on traditional consumption industries, privately-held start-ups wield an increasing amount of power. They are not being held to account by public shareholders and regulators, or at least not yet.

In almost every developed market in Asia, private equity has come under more direct scrutiny as a result of the messy fallout from buyout transactions, which though relatively few in number, attract a disproportionate amount of publicity.

Whether private equity firms are lobbying governments regarding how they are treated or supporting portfolio companies that face administrative hurdles in certain markets, it is in their interests to forge constructive relationships with regulators. The industry must make its voice heard.

 

 

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• Topics
• South Asia
• Regulation
• Fundraising
• India