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Depreciating rupee and IT firms - Views on News from Equitymaster
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  • Jun 17, 2008

    Depreciating rupee and IT firms

    Software firms have got a reason to cheer. Indian IT companies are making the most of a depreciating rupee, as more than 80% of their revenues are coming in dollars. The depreciating trend of the rupee against the US dollar and other currencies the over last six months is boosting the margins of the IT companies. A 1% fall in the rupee usually results in a 0.3-0.5% gain in the operating margins of most of the IT companies, and vice-versa. Therefore, IT firms have more to gain from a depreciating currency as this would guard their margins even in the midst slowdown and lesser IT spending.

    In this article we analyse the reasons for the recent depreciation in the rupee and how its movement will impact Indian IT firms in future.

    In last two years rupee appreciated by around 20%, but in last six months it depreciated by 8% against the US dollar. In 2007, rupee touched a high of nearly 38.5 against the US dollar but after that is started depreciating and is currently trading at 42.95 against the US dollar. The key factors behind the recent depreciation of the rupee are:

    • Strengthening of the US dollar after Fed statement about curbing inflation and halting interest rate cut.

    • Higher crude oil prices, which deepened the current account deficit and increase dollar buying by oil companies.

    • Slowdown in capital inflows because of credit crunch

    • Unwinding of positions that were betting on rupee appreciation

    Indian rupee, Chinese demand & more

    Where the rupee is headed?

    Medium-term view
    In medium term we do not see the rupee upholding its strength against the US dollar. Global credit crunch, slowing capital inflows into India in the form of FII, FDI and private equity, soaring crude oil import bill and moderating export growth suggest that the current account deficit will worsen, which in turn would continue to weaken the rupee.

    Long-term view
    The BRIC report by Goldman Sachs predicts that India would be the third-largest economy in the world by 2050, growing at a rate of almost 9% per year for fifty years. It also says that with the strengthening of the Indian economy, the rupee would appreciate by more than 2% against the US dollar per year for next forty years.

    Although the long-term outlook for rupee is strong, in the medium term, rupee would continue to remain weak against the dollar until the inflation rate moderates, ECB restrictions remain and the international money does not rush back into India. Thus although in the medium term IT firms will be able to get the advantage of depreciating rupee in improving its margin, in the longer term these firms will get impacted by the appreciation of rupee if they do not reduce their dollar dependence by getting into non dollar markets. Only those IT firms would be able to give superior returns in future, which have diversified their revenue sources in different geographies like Europe, Middle East, Asia and Africa and generating revenue in diversified currencies.



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