Funding for AI startups in India sees a massive drop, causing shockwaves in the tech world. Despite global AI funding surge, Indian startups struggle with market volatility. Experts reveal the challenges hindering AI innovation and funding growth in the country.

Funding for AI startups in India stood at $8.2 million in the April-June quarter, declining about 91% sequentially and by 82% year on year, data sourced by ET from market tracking firm Tracxn showed.

Funding for AI startups in India stood at $8.2 million in the April-June quarter, declining about 91% sequentially and by 82% year on year, data sourced by ET from market tracking firm Tracxn showed.

The data includes equity funding of AI infrastructure and AI-as-a-service tech startups.

“The decline in funding can be primarily attributed to the highly volatile market due to geopolitical tensions (and) rising interest rates, among others We expect this sector to grow in the near future once market conditions stabilise,” Neha Singh, cofounder of Tracxn.

AI startups accounted for only about 0.3% of the overall tech startup funding, which stood at about $3 billion, in the June quarter.

Globally, however, AI startups have been defying the ‘funding winter’ plaguing startups post pandemic.

In the US, for instance, AI startups received $27 billion in funding in April-June, accounting for nearly half of all startup funding in the country during that period, the New York Times reported, citing Pitchbook data. AI startups for the first time became the largest segment during that quarter, as per Crunchbase.

Calendar year-to-date, Indian AI startups have raised nearly $96 million, which is a 61% increase over the same period in 2023, though an 82% decline compared to the first half of 2022 – the year AI funding peaked at $560 million for the whole year.

In India, investors are applying the brakes after initial euphoria around the technology due to the lack of winning use cases with a clear return on investment amid a scattered investment landscape with numerous AI startups, said Rohit Pandharkar, AI partner at EY.

Yet, AI remains the “hottest theme”, he said.

Further, enterprise demand is muted due to confusion around where to spend and the cost equations of scaling AI solutions.

AI startups are also now being challenged as large global tech companies incorporate AI – including vernacular capabilities – into their offerings and consultants and IT services providers are available to build use cases for enterprises using open-source models, Pandharkar said.

Investors remain bullish in the long term despite existing concerns.

“Numbers around AI investing need to be taken with a pinch of salt… AI today is like the cloud – almost every new startup is utilising it to varying degrees,” said Alok Goyal, partner at Stellaris Venture Partners.

Stellaris is “very bullish on the outlook for AI-centric funding”, he said, adding that more than 50% of its investments in the last 12 months have gone into AI-first startups.

Further, given the democratisation of AI capabilities across the world in recent times, Indian startups are poised to benefit as much as those in Silicon Valley, he said.

Deepak Sharma, cofounder of seed stage startup accelerator India Accelerator, said the ⁠cautious approach by enterprises on security and data-related issues of GenAI, the high cost of AI infrastructure including GPUs, and the lack of AI talent are among the major hurdles.

India Accelerator is optimistic about AI startups solving enterprise use cases in the areas of software engineering and productivity, sales and marketing, customer ops and R&D, Sharma said.

The accelerator has committed an investment of Rs 30-40 crore over the next two years across 20-25 startups, he said.

Experts said venture capital firms have ample dry powder and are not hesitant but waiting for investable bets.

The opportunity lies in AI applications, tooling, testing and so on, but the Indian ecosystem cannot support too many startups in the AI infrastructure and foundation AI layers as they are capital intensive, they said.

“Deals are also being announced later as startups are building in stealth. We are aware of at least 15 AI investments which are yet to be announced, including one from SenseAI,” said Rahul Agarwalla, founding partner at SenseAI Ventures, an AI-focused fund that plans to deploy Rs 200 crore in the next 2-3 years in early-stage startups.

SenseAI expects India to produce 100 AI unicorns in the next decade, which would require adequate capital over time, Agarwalla said.

Jeyandran Venugopal, chair of DeepTech Council at industry body Nasscom, said the country’s deep tech sector needs targeted support to catch up with its international counterparts, including strengthening of innovation clusters, facilitating robust compute infrastructure, and boosting the overall supplier ecosystem, including the talent pipeline.

“Deep tech sector is characterised by its complexity and high entry barriers, necessitating patient capital, a robust intellectual property regime, and a longer timeframe for market entry,” he said.

Notable AI startups that raised funds this year include Indic LLM-maker Krutrim, which raised $50 million and became India’s first AI unicorn, and AI cloud and platform-as-a-service startup Neysa that raised $20 million.