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Software: Rising crude prices a concern!

Aug 24, 2004

The headline might seem inconsistent with all those reports citing reasons for investing in stocks from the software sector as a defensive strategy, as 'all' companies are believed to be insulated from the recent rise in crude prices. However, if there is a reason to believe that rising crude prices have the capability to derail the recovery in the global economy, there are all the more chances that this economic slowdown 'might' further affects prospects of the Indian software industry.There is a valid point that the global economic slowdown, if at all it happens, will further advance the prospects of outsourcing into India as corporations will try to become more competitive in times of pressure arising from reducing demand and declining margins (on account of rising cost of inputs). However, if the slowdown were to sustain for a long period of time, Indian software companies might be affected in terms of reduction in demand for new software development, the largest contributor to revenues for these companies.

Also, the pangs of slowdown might lead to clients once again demanding finer billing rates from services the Indian software companies provide. This might further result in pressure on margins for companies that fail to increase employee productivity through providing services that are at the higher end of the value chain, i.e. companies which are mainly engaged in software development and maintenance.

In short, if the crude prices continue to rise and sustain at high levels, the resultant slowdown in the global economy is likely to have an adverse effect on the slowdown of growth for the Indian software companies. However everything is not gloomy for Indian software companies. Rising crude prices might lead to an appreciation in the value of the US dollar vis-a-vis the Indian Rupee as demand for the currency to pay oil exporters will rise. This means that India software companies will show better growth in topline as most of their earnings are in Dollars.

In these circumstances, and keeping all the above factors in mind, investors (both current and probable) who are interested in stocks from the Indian software sector need to understand their risk return profile. A blindfold approach toward investing in these stocks with a view that these are insulated from the current events might turn out to be short sighted. However, investments in those companies that have visionary managements, track record of consistent growth and increasing revenue contribution from high-end services might insulate investors from the vagaries of current events and provide them with adequate return over the long-term.

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