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Pharma: The rising rupee impact

Sep 25, 2007

While the rupee has been on an appreciating trend since the beginning of 2007 reaching 40.58 levels, last week was witness to the Indian currency breaching the psychological barrier of 40 to trade at 39.80 levels. The US Fed taking the decision to cut interest rates by 50 basis points to 4.75% was certainly the prime reason that led to this sharp appreciation. This rate cut meant that the interest rate differential between the domestic interest rates and the US interest rates has widened causing the surge of Foreign Institutional Investors (FIIs) money into India. This rising rupee is expected to have a negative impact on export-oriented sectors such as software, textiles and pharmaceuticals. In this article, we shall take a look at both the negative and the positive impact of the rupee appreciation on the pharma sector.

The challenges...
Impact on revenues: In the last few years, domestic pharma companies have been increasingly focusing on the exports markets of the US and the Europe to capitalise on the generics potential and also to mitigate the long-term impact of the likely slowdown of product launches in the domestic market in the future. As a result, many of the top domestic companies have a strong exposure to the exports markets and the rise in the rupee is definitely expected to impact revenues in the near term. US being the largest pharma market, besides the big players, even the mid-sized players are concentrating on this market, if not directly, then through the partnership route (CRAMS for instance). Top pharma companies such as Ranbaxy, Dr.Reddy's, Cipla, and Wockhardt for instance derive around 60% to 80% of their revenues from exports.

Impact on profitability: Given the margin pressure that the generics companies have to contend with in light of the increasing competition and brutal price erosion, the appreciation of the rupee is likely to further deal a blow and impact margins largely due to a dent in realisations.

The other side of the coin...
Fall in value of imports: Unlike the software sector, the pharma sector does enjoy the benefit of a natural hedge in the form of imports especially on the raw material front. Of late, pharma companies have been witness to increasing raw material prices. Many of them import intermediates (used for making APIs) from China, which is very strong in the manufacture of the same. However, China has curbed the export incentives for pharma exports amongst others (to control its trade surplus) and as a result, the import of intermediates has become expensive thereby leading to a rise in raw material costs. Thus, while raw material prices are increasing, the rising rupee is likely to cap the increase to a certain extent going forward thereby easing the pressure on margins.

Impact of foreign borrowings: Given the intense competition in the generics market, domestic pharma companies like their global generics peers are looking to acquire scale to counter this pressure and thus have been very active on the acquisitions front. Not to be left behind, players focusing on the CRAMS model have also been acquiring companies abroad. However, the price paid for the same has been a tad on the higher side and many of them have been taking recourse to debt to fund these acquisitions. The most popular have been the raising of zero coupon FCCBs and ECBs. As far as the former is concerned, while companies do not have to pay interest, the appreciating rupee could ease the payment pressures during the time of redemption (assuming that there is no conversion). Also, companies are expected to benefit from the mark-to-market forex gains. In the case of ECBs, the rising rupee could reduce the interest expenses going forward.

To conclude...
While US has and will be a major market for domestic pharma companies, some of them are turning their attention to Europe, which could reduce the dependence on dollar denominated revenues to a certain extent, going forward. Having said that, while the pressure of the rising rupee is here to stay in the near term atleast, those companies which continue to launch new products, expand geographically and control costs will be in a better position to withstand the pressure going forward. Also, at the end of the day, while it is not easy to completely eliminate forex risks, it all boils down to what prudent risk management measures pharma companies are adopting to hedge against the same.

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