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Rupee appreciation: Hits and misses

Dec 7, 2004

After depreciating by 6.2% between April 2nd 2004 to August 6th 2004, the Rupee has appreciated by as much as 5.7% since then. While most attribute this appreciation to the greenback's weakness as opposed to Rupee's strength, one cannot ignore the fact that it has implications on the stock market and profitability for India Inc. Without getting into the complexities of why the Dollar is tumbling, we take a closer look at the top importers and exporters of the country and what is the magnitude of impact? The data is of FY04 from the Quantum Universe of 350 companies. All figures are as a percentage to sales, on a standalone basis. We have divided the export dependent sectors into three sets i.e. software, pharmaceuticals and companies from other sectors.

The exporters lobby (% sales - FY04)
Software Pharma Other sectors
Satyam Computers 90.2 Wockhardt 36.6 Nalco 55.3
Hughes Software 94.3 Cipla 44.1 United Phosphorus 57.3
Geometric Software 95.1 Lupin 47.3 Satnam Overseas 57.6
Infosys 95.2 Aurobindo 51.0 Ashapura Minechem 58.6
i-flex 95.3 JB Chemicals 51.8 EIH 58.6
Mastek 95.9 Dr. Reddys 58.9 Hotel Leelaventure 66.5
Digital 98.2 Biocon 59.8 Sesa Goa 69.7
Patni Computers 99.6 Ranbaxy 62.4 Welspun India 74.3
Mphasis BFL 99.6 Orchid Chemicals 76.6 Himatsinka Seide 92.5
VisualSoft 100.0 Divis 85.4 Suraj Diamonds 92.8

Given the fact that software exports (including ITES) accounted for an estimated 17.9% of the country's exports in FY04, it is not surprising to see that the contribution of exports to revenues of technology companies are higher. But there is one crucial factor, which investors need to consider. While the Rupee has appreciated against the Dollar, the rupee has actually depreciated against the Euro for the period between August 6th, 2004 to December 1st, 2004.

What is therefore important to consider here is the contribution of US to total revenues of software companies, which are dollar denominated. Based on our estimate of the top three software services companies in India viz. Infosys, Wipro and TCS, US accounted for 59.8% of combined revenues in FY04. Therefore, the recent Rupee appreciation will have a negative impact on the software sector. The magnitude of impact is likely to differ between companies. Our interaction with five of the software services companies suggest that the companies have hedged themselves against the Dollar for the next twelve months and to that extent, the impact is mitigated. The new contracts that are likely to be signed from here on will factor in this rupee appreciation and to that extent, there will be a negative impact. Having said that, considering the strong move towards offshoring in the global markets, higher growth in revenues could partially negate the Rupee appreciation.

Moving away from software companies, domestic pharma majors are also highly dependent on exports viz. US, Europe, South America and SAARC countries. Of the consolidated revenues of Ranbaxy, 43% was accounted by the US markets in FY04. In the case of Dr. Reddy's, the contribution stood at lower at 28% in FY04. While companies like Biocon, Nicholas Piramal and Wockhardt do not have significant US contribution as of now, going forward, this is likely to increase and to that extent, margins may be affected. Besides pharma majors, other sectors from the list that are highly dependent on exports are hotels (Hotel Leelaventure and EIH) and Nalco. On a conservative basis, dollar denominated revenues account for atleast 60% of room revenues of hotel companies. While the removal of the quota regime is a positive for the textile sector, if rupee continues to trade firm or appreciate, it may not be that profitable. In this context, expectations need to be realistic.

The importers lobby (% sales - FY04)
Energy & petrochem Other sectors
HPCL 18.1 Mercator Lines 56.9
Gulf Oil 18.9 Welspun Gujarat 60.0
Southern Petrochem 22.1 Apar Industries 60.5
Flex Industries 24.3 D-Link India 63.8
IOC 31.0 Sterlite Industries 66.7
Finolex 36.0 Zuari Industries 68.6
Chennai Petro 60.7 Suraj Diamonds 75.1
Kochi Refineries 62.4 Moser Baer 76.1
Reliance 65.2 STC India 78.9
MRPL 67.0 Godavari Fertilisers 86.3

The key beneficiaries from the Rupee appreciation are importers, as the Dollar is now worth less for every rupee or to put it in different terms, less rupee can buy more dollar denominated assets/commodities/goods. Among the importers, companies from energy dependent sectors are likely to benefit in a significant manner (energy, paints and few textile majors). Companies that source raw materials from the global markets and are largely domestic demand driven could potentially witness margin improvement. Besides companies, rupee appreciation is also a positive for the government's financials and capital goods sector (most of the equipments are imported, as the country is technology deficient).

To conclude, as India's trade with global markets increase (this includes imports, exports, FII inflow and FDI inflow), the impact of exchange rate movements cannot be underestimated. At times, adverse exchange rate movements could affect money flow into the country. Since exchange rate movement is not only dependent on what is happening in India but also in the US and other economies, the complexity increases dramatically.

Without trying to be 'doomsayers', investors need to take a balanced view on factors like exchange rate, interest rate trend in the US and so on, before jumping onto the hot 'India story'.

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