As IT majors roll out their quarterly numbers, they want spotlight on constant currency or rupee earnings. The reason is not hard to find. Cross-currency volatility is gnawing at the profit margins of almost every tech company.
Third quarter results of the top-three companies of the Indian IT industry?TCS, Infosys and Wipro?have confirmed pressures on pricing and tightening of IT budgets. But the high fluctuations in global currencies like the euro, pound and the Australian dollar, relative to the US dollar, have proved to be the biggest dampener on margins.
In fact, movement of non-dollar currencies has undone the gains from rupee?s downward movement against the US dollar. When Indian IT companies were first exposed to the rupee-dollar volatility in the summer of 2007 (that time the Indian currency was strengthening against the greenback), they had hedged themselves against the dollar.
However, while the rupee movement reversed some months ago, IT companies and their CFOs were caught off guard this quarter as other currencies showed unexpected volatility for which they had very little hedges in place. Having burnt their fingers once, companies are now stepping up their cross-currency hedges.
Consider this: During the October-December quarter, the pound dropped 18% against the dollar and the euro slid by 11%, while the Australian dollar fell 23%. As a result, India?s largest technology company, TCS reported around Rs 250 crore of forex losses. Infosys Technologies, the second largest technology company, was not far behind with Rs 218 crore forex losses. The company has $576 million worth hedges down from the earlier $932 million the previous quarter.
Even medium-sized companies like NIIT Technologies (forex loss of Rs 13.9 crore) and Zensar Technologies (Rs 7 crore) saw their net profit being pulled down by huge forex losses. So far the third-largest Indian IT company, Wipro Technologies, has been the only company to report gains on back of currency fluctuations. In the third quarter of financial year 2008-09, the company which had $1.8 billion of total hedges had a forex gain of Rs 186 million. Industry experts call it a play of aggressive and accurate hedging.
Infosys COO SD Shibulal says that the company will step up its non-dollar revenue hedging from this quarter as there have been sharp cross-currency movements. ?About a quarter of our revenue today comes from Europe and 8.8% from the rest of the world. A part of this revenue comes in other currencies like pounds and Australian dollar and we will now start hedging these too. We always take a short-term view and hedge for two quarters,? he says. TCS too went on record to say that it will closely watch currency moments as it gets 20% of its revenues from the UK.
?Historically, the currency movement has been relatively monotonous from the point of view of exporter of services with a slight exception in 2000 after the Kargil War when there was some volatility. Therefore, IT companies had a large portfolio of exposed currency and we never saw an active managing of that currency as being done today,? says Vikash Jain, associate principal, Everest group, an IT consultancy firm.
He adds that earlier Indian IT companies used to get around 80-90% of their revenues from the US market and whatever was derived from other countries was also billed in US dollars. But, this trend has significantly changed over the past few years.
Moreover, after the rupee started to appreciate against the dollar last year, nobody had expected it to rebound so quickly. ?As problems started to surface in the economies of UK and Europe there was again a flight of investment to the US treasury which led to the dollar rising,? says Jain. This reverse trend rendered a lot of hedges unhelpful leaving companies in a new dilemma. While most IT firms now have forward covers in place to take care of the rupee-dollar movement, they have little hedging cushion in terms of cross-currency fluctuations.
For instance, TCS has 21 outstanding forward contracts against the US dollar but has only one each for sterling pound and the euro as on December 2008. Its number for currency option contracts for US dollar is 43, sterling pound is 2 and the euro is 10. On the other hand, Infosys has $185 million worth of outstanding forward contracts for the dollar, 17 million for the euro, 8 million for the pound and 3 million for the Australian dollar as on December 2008. It has range barrier options worth $269.50 million against the dollar but none against other currencies.
?In these market conditions where it?s very difficult to predict which way the currency will move, the wisdom is in taking hedges that are not too long term. The best way to hedge for an IT company is to match it with the contract duration,? says Rajagopal S, partner, mergers and acquisitions, Grant Thornton India. He adds that Indian IT companies have to now go for comprehensive hedging policies as a next step to avoid not just their revenues and profit margins being im pacted by the currency fluctuations but also to protect their net investment in various countries being eroded.
Taking a different view, Apurva Mehta, associate director, KPMG says that Indian accounting standards do not penalise companies for not marking to market their exposure which leads to such losses. ?International IT companies which have huge exposure to foreign currencies like IBM or Accenture have a very proactive financial department which is in constant touch with the business department on the deal inflows which can be hedged in anticipation. This protects them from such losses,? he says.
Well, now that Indian IT companies are bracing themselves up to deal with such situations better, experts feel that the current level of these currencies is the best (and safe) level to hedge at. However, they should take a short to medium level (6-12 months) view at such hedges.