Imported Raw Materials Hurt PVC Pipes, Capital Goods As Rupee Depreciates: Crisil

The volatility that the Indian rupee has witnessed against the US dollar is also expected to trickle down to the earnings in certain sectors in the current financial year, according to Crisil Ratings.

Despite this projected earnings turbulence in specific areas, Crisil estimates that the overall impact on the credit profiles of companies included in its portfolio to be neutral.

The Indian rupee has experienced fluctuations in its exchange rate with the US dollar over the past months. The rupee depreciated to Rs 87.40 by Feb. 28 before subsequently appreciating to Rs 85.65 on April 3. These recent patterns of sharp movement contrasts with the relatively steady depreciation of the local currency, ranging between 1% and 2%.

While the rupee has shown some strengthening in recent times, Crisil Intelligence projects that this trend would not persist, and the rupee is expected to continue depreciating against the dollar, before settling at around Rs 88 by the end of the fiscal year.

A notable depreciation in the value of the rupee typically results in a substantial increase in costs for sectors that have a certain reliance on imported or dollar-denominated raw materials. This cost inflation occurs without a much increase in their revenue. This puts a downward pressure on both earnings and profitability.

The PVC pipes and fittings sector serves as an example, as it imports approximately 50% of its raw material requirements. These companies have some capacity to pass on the increased input costs to their customers via price adjustments.

Despite this, the feasibility and speed of such mechanisms are dependent upon the prevailing strength of market demand. This lag could lead to a negative impact on the operating profitability of these players and this is estimated to be in the range of 50 to 100 bps. Further, the movement in raw material prices can also lead to inventory losses for these companies.

The capital goods sector presents a similar picture due to its diverse nature as well. Facing the same import problem, capital goods players are also likely to experience a decline in their profitability, according to the report.

The segments of the capital goods sector that primarily focus on the export of finished products are expected to benefit from the weaker rupee. The dollar-denominated revenues of these players translate into higher rupee earnings.

In the pharmaceuticals sector, particularly in active pharmaceutical ingredients and the renewable power sector are anticipated to face marginal pressure on their profitability and project returns.

This is also due to the dependence on imported raw materials, such as intermediates for pharmaceuticals and modules for renewable power projects.

On the flip side, the depreciation of the rupee is expected to provide a boost to sectors that are primarily export-oriented. These sectors include IT, marine foods specifically shrimp and prawn, and home textiles, where exports account for a majority of their total revenue.

These sectors also have import requirements that are negligible. In both cases where the companies choose to retain the benefits or pass them on to customers in the form of lower prices, their profitability could improve up to 100 bps.

For other sectors such as pharmaceuticals, chemicals, gems and jewellery, and ceramics, which also have foreign trade exposure, the overall impact of the rupee depreciation is likely to be neutral.

This neutrality is due to the presence of a natural hedge as these sectors have a substantial presence on both the import and export fronts, according to Crisil.

This balances the impact of currency fluctuations. Similarly, sectors like city gas distribution, primary steel, and edible oils are set to see only minimal impact from rupee volatility as they pass on changes in input costs to their customers.

While the near-term impact on the earnings remains a factor that will need to be monitored, the overall credit impact is expected to be neutral.

This is because the initial effects of rupee volatility are will be neutralised as businesses adapt to the new currency exchange rate levels. The specific impact on companies will also depend on their outstanding debt.

A depreciating rupee would inflate the rupee value of dollar-denominated liabilities, potentially leading to higher debt obligations, which could negatively affect their credit profiles, it added.