A fall in the value of the rupee should, in most conditions, be a positive for the Indian information technology industry, which gets most of its revenue from overseas, especially the United States. The recent slide of the rupee, which has lost 5 per cent of its value since the start of the fiscal year, should have been good news for the Indian IT industry. Instead, IT stocks have fallen, with the IT index losing over 6 per cent since April. Here are 5 facts on why this is happening.
1) INR v/s IT index trend:
The INR has depreciated around 5 per cent in CY 2012 so far. However, both the BSE IT and CNX IT index have fallen around 2 per cent for the same period. This shows that near-term movements in the rupee have little demonstrable effect on fundamental stock valuations. “With Indian IT expected to grow at not more than 10-12 per cent for FY13 in US$ terms, we do not believe the recent rupee appreciation alone gives cause for much cheer,” a report by Spark Capital said on Wednesday.
2) International demand v/s rupee:
Indian IT is geared to international rather than domestic demand. Hence, the market reacts negatively to any concerns in world economy because this offsets any gains from forex fluctuation. US and Europe are two of the largest markets for the Indian IT sector, both of which are currently seeing a slowdown in growth and labour market. This is likely to affect demand for Indian IT services in the near-term and drive down revenues, which could render forex gains irrelevant, depending on relative value. “In the long run, nearly all of IT spend is discretionary; and a mere depreciation in the rupee does not alleviate market concerns on underlying demand,” the Spark Capital report explained.
3) Historical trends:
The trend was the same in 2008-09, when the US was hit with a financial crisis and slipped into recession, the Spark Capital report points out. The US dollar was around Rs 45-46 levels just prior to Lehman Brothers' bankruptcy in September 2008. But, by the end of March 2009, the US$ had appreciated around 11 per cent against the Indian rupee. However, the CNX IT index did not mirror this positive development; in fact, it reflected just the opposite movement and declined over 40 per cent during this period. The broader Indian equity market, in comparison, only fell around 30 per cent.
4) Cash generation from forex fluctuations:
IT companies generate cash as they get more rupees for every dollar they receive. The impact is seen across the income statement – in revenue, operating profit and net profit. The key variable here is the percentage of revenue from offshore. As this percentage increases, leverage from INR depreciation increases. Percentage of cash generation due to forex fluctuation to the revenue is limited and varies for different companies. If one assumes Rs 52 per dollar as the exchange rate, cash generation could increase by as much as 25 per cent over the next two years for companies like Persistent Systems and HCL Tech.
5) Hedging:
Companies hedge against potential fall or rise in currency values. This is done by taking a contrarion position in currency markets. So, if a company that exports, fears that its revenue or profit could be affected by a sharp surge in the rupee, it could make up for those losses by hedging.
Cash flows arising from realized hedging losses/gains too differ for different companies in the IT sphere. According to the report, Indian IT firms tend to vary widely in their use of currency hedges. “At one end of the spectrum are companies like eClerx, while on the other hand we see companies like Infosys which has very limited hedge coverage for FY13,” the report said. Also, some companies like Infosys have had more or less consistent hedging policies from quarter to quarter, while others might pare their hedge books in the wake of recent INR weakness. Hence, it is difficult to generalize the positive impact of rupee depreciation for the sector as a whole.
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