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Protectionism fears

Jan 27, 2004

The outsourcing story, that began with the software industry and now has gradually spread across various sectors of the Indian economy, has changed the way the international business community views India. India is now arguably called the services back office of the world, just as China is called the manufacturing hub of the world. However, while the India offshoring model is being replicated even by multinationals, the offshoring phenomenon itself seems to be under threat.We are referring to the rising wave of protectionism that has been witnessed off late in the Western countries like the US and UK against outsourcing of IT related work to India. The US senate recently passed a bill that bans outsourcing of US government contracts (not yet a law). One may argue that in the US, this protectionist sentiment is more a manifestation of pre election jitters that the government is experiencing. After all, even the US goes to polls in 2004. Coming back to the Indian context, should investors be worried about this new wave of protectionism or should they rest easy?

The reaction, by the Indian software industry to the new bill, indicates that due to the small size of contracts from the US government (to third party Indian vendors), the impact of the new bill on Indian companies is likely to be minimal. Of the total Indian software exports, only 2% is on account of US government contracts. However, the industry also points out that while this bill may just be a flash in the pan, the Indian software industry does need to tread with more caution. To that extent, industry experts point out that it is still too early to say whether this is just a passing phase.

As far as the retail investors in India are concerned, one aspect that needs to be clarified is that, the high valuations of certain Indian software companies are in part due to expectations of higher benefits from outsourcing. Thus, if this protectionist movement spreads to the whole of corporate America, investors may witness a slowdown in the prospects of the Indian software companies. While the chances of protectionism spreading to the whole of US Inc. are very unlikely, investors need to be cautious.

In this context, we would like to point out that such kind of adverse conditions tend to mitigate over a long-term period and hence we advocate a long-term investment horizon for retail investors. Stick to companies that have managed to outperform the industry over the long-term.

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