Asia's start-ups start to squirm as contagion fears linger, easy money dries up

Global investors watched in horror over the past month as two US banks collapsed and struggling Swiss finance giant Credit Suisse was taken over by rival UBS, triggering concerns it could spark a contagion effect that would spread to Asia in the same way as the global financial crisis of 2008.

Analysts say most Asian banks learned from that episode and are well positioned to ride out the current turmoil. But they warn of higher borrowing costs and tighter lending conditions, which could disrupt venture-capital funding for the region's start-ups.

Silicon Valley Bank (SVB) failed after depositors lost confidence in the business and flocked to withdraw their money as high interest rates eroded the value of its long-term bonds. This also spooked customers of the New York-based Signature Bank, which likewise had a large amount of uninsured deposits, causing US regulators to seize control of both lenders.

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Unlike in the US and Europe, however, many Asian banks - outside Japan - are used to operating in a high interest-rate environment, said Jamus Lim, associate professor of economics at the ESSEC Business School, Asia-Pacific in Singapore. They are also adept at juggling domestic interest rates with exposure to US rates and exchange risks, he said.

After the crisis of 2008, many Asian banks "would have built up better reserve buffers and not relied on a thin layer of capital," Lim said. "That said, there will be regional banks that will be hit more, and should the effects of the recent bank failures in the West become more generalised, then all bets are off."

At the moment, such a dire scenario looks unlikely - although it can't be ruled out.

US regulators have backed the sale of SVB's assets since its sudden collapse - calming panicky investors - and Switzerland's central bank threw Credit Suisse a US$54-billion lifeline last month after the value of its shares and bonds slumped, paving the way for its takeover by UBS.

Similarly, Lim expects Asian central banks "to step in decisively to offer necessary liquidity" if there are further signs of trouble.

"The banking crisis in the US was driven by a clumsy regulatory framework that allowed small-size banks to take excessive risks without accounting for market values," said Arturo Bris, a finance professor and director of the IMD World Competitiveness Centre at the International Institute for Management Development in Switzerland, who insisted that "no [global] financial crisis will ensue".

Ample liquidity and limited exposure to long-term bonds of the type that bled SVB dry will allow most Asian lenders to keep their heads above water, analysts say, but the crisis will lead to growing caution as tighter credit conditions continue to torment global markets and steer the US economy towards softer growth.

The US Federal Reserve started raising interest rates about a year ago to control inflation as the war in Ukraine disrupted supplies of raw materials, leading to rising food and energy prices. Last month, the Fed raised rates by another 25 basis points - its ninth straight increase.

Though America's central bank is expected to ease up on the rate increases to mitigate the woes of the country's smaller banks, it's unlikely to actually start cutting rates until it gets a handle on inflation. And it remains anyone's guess how long it will take until that happens.

In the meantime, higher borrowing costs will continue to weigh on the world's largest economy. That's likely to affect Asia's exports to the US, though investment bank Morgan Stanley said in a report on March 19 that it forecast the impact on the region's growth to be "more muted".

China's reopening this year could lessen the pain for Asian economies by providing an alternative export route, but if the US economy does drop into a prolonged recession, then the downside will become more meaningful.

"We don't think Asia will be immune to the downward pressure on developed markets' growth from recent issues in the banking sector," Morgan Stanley said in its report.

The uncertainty in financial markets has led global investors to lower their appetite for risk and shift their attention towards safer assets. This could disrupt funding to venture-capital firms, which may lead to less equity capital for start-ups and medium-sized companies, said Francisco Widjojo, managing partner at Indonesia-based Arkblu Capital.

"Banks and financial institutions may impose stricter lending standards, making it more difficult for these businesses to access loans or credit," he said, adding that borrowing costs are likely to rise due to "increased conservatism".

"The banking sector's troubles will likely lead to tighter lending conditions and higher borrowing costs for start-ups and medium-sized companies irrespective of the rate hike."

Such a high-rate environment marks a sharp reversal from two years ago, when central banks were offering cheap money to combat a pandemic-induced slowdown.

Then, many Asian start-ups embarked on a growth-at-all-costs strategy by burning through cash, but analysts say several are now paying the price as they've been left with surplus funds that are only sufficient to cover about six to eight months of operations.

High inflation has also eaten into the margins of start-ups and medium-sized companies as consumer spending has slowed in regional countries like Indonesia, Widjojo said.

"Overall, the Federal Reserve's rate hikes will mean rising interest rates and this will constrain tech firms - regardless of size," said Vinnie Lauria, founding partner at Golden Gate Ventures.

The Singapore-based venture capital firm has been advising clients to focus on strong business fundamentals rather than growth-at-any-cost in the current climate, Lauria said, adding that Southeast Asia could emerge as a safe haven for start-ups by following such a strategy.

Higher borrowing costs driven by central banks' rate increases have been affecting Asian start-ups for months now, and the recent crisis of confidence in the US is unlikely to help matters.

Two years ago, India was minting unicorns - as privately held start-ups with valuations of more than US$1 billion are known - at a record pace as global investors flocked to its sizzling tech scene, which soon overtook Britain's to boast the third-largest number of start-ups in the world.

Since late last year, however, the South Asian country has not seen a single new unicorn. Industry executives say several firms that had built their businesses by depending on cheap injections of cash may be on the verge of a collapse as easy credit has dried up.

"There are actually a few of India's 108 unicorns who will fall under that model," said Siddharth Pai, founding partner of Bangalore-based 3one4 Capital and co-chair of the India Venture and Alternate Capital Association's regulations affairs committee.

The funding crunch could cause the collapse of entire sectors and not just some individual companies with faulty business models, he said. Education technology is one of the sectors that's looking the most vulnerable as investors overestimated the long-term effects of the pandemic on online education.

Indian edtech companies' market capitalisation - their value as traded on the stock market - has ballooned past the value of India's entire education market, which was estimated at US$10 billion by a PwC report in 2021, Pai said.

Uncertain financial conditions have also prompted companies to embark on a cost-cutting spree, reducing the scope for start-ups to launch new products aimed at other businesses, he added.

As a result, some start-ups' fall from grace has been swift and sharp. Online food-delivery company Zomato, for example, debuted on India's benchmark Bombay Stock Exchange in July 2021 with shares selling at a premium of 51 per cent, but they are now trading at 30 per cent below the issue price.

Several other tech-based companies such as Delhivery and Cartrade are also trading below their IPO price, after briefly touching sky-high valuations.

Industry insiders say some start-ups have started defaulting on their interest payments, and venture capitalists are no longer willing to invest as much as they previously did.

Anurag Singal, founder of Indian financial services firm BetaFin Partners, said venture capital funds were starting to revisit company valuations, which often translated into either lower sums of money being offered or the funds seeking higher equity stakes in the company.

Global investors have made clear that they need to see a clear path to profitability, he said, citing the recent example of a Singapore-based investment syndicate that did not budge on such a demand for financing a start-up.

Pai estimates that for India alone, investors are sitting on about US$14 billion to US$16 billion that they raised last year but will not deploy until market conditions stabilise.

For those companies that are able to achieve the holy grail of profitability and stable revenues, however, funding is still available.

Omnivore, an India-based venture capital firm that funds food and agriculture entrepreneurs, is preparing for a third funding round in a couple of weeks to raise about US$130 million from global and domestic investors - which would surpass the US$95 million it raised in 2017-18 and US$45 million in 2012-13.

"We did not see any downturn, but agritech never saw the euphoria of tech investments where valuations ran ahead and people were putting money left, right and centre," said Jinesh Shah, one of Omnivore's founding partners. "Maybe valuations in agritech have gone down by 10 per cent to 20 per cent. But it is not in a dire state."

Shah attributes the firm's success to its focus on profitability from the outset, as well as the sector's appeal as a supplier of essential commodities that are always in demand. Around 80 per cent of the fund's investors so far have been European banks and financial institutions, as well as US investors to a lesser extent in the second round.

It expects the same pattern of funding during its third round, but also hopes to rope in investors from other regions apart from Asia, Europe and the US as part of a strategy of risk management.

Shah said the decision to diversify its investor base was made long before the collapse of SVB, which has been criticised for concentrating too heavily on start-ups as depositors, making it vulnerable to capital flight.

Yet the US bank's failure will negatively affect Southeast Asian start-ups that relied on it for cash flows, said Chen Zhuling, founder and CEO of Singapore-based blockchain company RockX.

"SVB was known for its focus on financing tech start-ups and had a strong reputation in the industry, so its absence could leave a gap in the market," he said.

Many of the region's start-ups that had looked to tap US-based investors via the bank - including those in the blockchain and decentralised finance sectors - would now need to look for an alternative, he said. But many companies are also likely to look at the current turmoil as an opportunity to strengthen their corporate governance and risk management policies.

Zhuling said rising interest rates would affect global investment patterns, including in Southeast Asia, but certain breakthrough technologies such as in artificial intelligence still hold the potential to offer returns for investors.

"Start-ups in Southeast Asia are likely to turn to funding within the region if they face challenges accessing capital from the US and other Western markets," he said.

This article originally appeared on the South China Morning Post (SCMP).

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