No gain, more pain for IT industry as cost crunch trumps benefits of Indian rupee slide

Written by Debojyoti Ghosh | Debojyoti Ghosh | P P Thimmaya | Bangalore | Updated: Sep 2 2013, 14:56pm hrs
TechnologyThe rupee's fall against the dollar is likely to increase the cost of operations over a period of time for the $108-billion Indian IT-ITes industry, eroding benefits that the depreciating currency usually brings for the sector's export-oriented services. (AP)
The rupee's fall against the dollar is likely to increase the cost of operations over a period of time for the $108-billion Indian IT-ITes industry, eroding benefits that the depreciating currency usually brings for the sector's export-oriented services.

Conventional logic has it that for every 1% fall in the rupee, the operating margins of IT services companies increase by 30-50 basis points (bps), but this is unlikely to hold true if the currency continues to trade at this level.

For the Indian IT industry, which is highly dependent on people, salaries account for 55-65% of the costs, and this component could see an increase if the declining rupee fuels inflationary pressure. Industry executives said the rising inflation rate due to a falling rupee will bring forth the demand for wage increase, and such hikes will impact profitability.

A depreciating rupee for one or two months will bring some benefits in terms of profitability but if this level sustains for a longer period, it will bring the pressure of hiking salaries while also increasing the cost of running our operations, Mindtree CFO Rostow Ravanan told FE.

The hiring in the industry is showing steady signs of pickup over the last few months and this will boost the demand for experienced human resources, which are in short supply, leading to competing wage hikes.

For HCL Technologies, the gains from the rupee's depreciation is likely to get absorbed due to negative impact of wage hike during the current quarter, said Angel Broking IT analyst Ankita Somani. The Delhi-headquartered IT firm announced a wage increase of 8% for employees in India and a 3% hike for on-site employees.

HCL Tech expects to have take a 60 bps hit on its margins in the current quarter.

The sharp decline of the rupee over the last few months is due to concerns over the high current account deficit (CAD), surging gold and other imports, and exports that are not buoyant.

Capital outflows on account of government policies and the international factors like the expected tapering of quantitative easing by the US Federal Reserve.

Tech Mahindra CFO Milind Kulkarni told FE while the opening of the swap window for oil companies, which are major importers ($8 to 9b/month), has relieved some pressure on the rupee and led to some appreciation in the currency, it is too early to predict the rupee's movement. IT companies like ours have a natural hedge against depreciating rupee but the benefits of depreciation are only transient, said Kulkarni.

The other major challenge for the IT-services industry from depreciating rupee would be increased cost of running their operations in the country. The declining rupee would also make it costlier for the IT players to send personnel for overseas assignments.

We are all part of this ecosystem, and we are going to be impacted by the depreciating rupee, Ravanan noted.

ISG Asia Pacific president Sid Pai an outsourcing advisory firm said, Good news in the short term since it will provide a margin cushion and also greater pricing flexibility while competing for deals. In the long term, it is not good news since clients will start pushing for discounts and local Indian inflation will erode the margin cushion.

However, the rupee has been bringing numerous benefits for the sector. In a recent report by Japanese investment bank Nomura Securities, TCS CFO Rajesh Gopinathan said, TCS expects the bulk of rupee depreciation benefits to flow through to margins in second quarter of the current fiscal, given that depreciation has been too sharp too soon. Over the longer term, the company will decide on the proportion of benefits to be reinvested on driving a higher growth by increasing sales spends, chasing deals with front-loaded transition costs and geographical expansion.

Ashwin Mehta and Pinku Pappan, analysts with brokerage house Nomura, pointed out that the improvement in the demand outlook, especially in developed markets, and on the discretionary side is likely to reduce pricing pressures, adding that the current leg of rupee depreciation of about 15% in the last three months has been too sharp and too soon while reinvestments only happen at a more gradual pace.

Experts feel that the current value of the rupee could leave many IT companies exposed as they dont have enough forex cover for their incoming revenue. Indian IT firms follow differing forex strategies, with some of them entering into long-term contracts while others take short-term positions.

Infosys takes forex cover of three to six months, while Wipro undertakes hedges at various levels of the rupee. TCS has adopted a cash-flow hedging strategy. This differing forex hedging strategy is also reflected in the kind of gains or losses each company makes on their exposure.