Rupee Reigning

Over the past six months, the dollar has plummeted, reaching its lowest level
in four years against the rupee. To some extent, the dollar's fall has been a
reflection of the sluggish American economy. The conventional view is that the
weakening of the US dollar is the result of the booming Indian economy and the
cautious steps taken by the government in this regard. Yet, could the fallen
dollar, particularly if it continues a weakening pattern, set conditions that
force the Indian software firms take precautionary measures so that their
bottomlines do not get affected as they have been for the last two quarters? But
the rupee's rise against the dollar has mixed blessings.

Impact on IT companies

For quarter 3, Satyam reported a bottomline decline of 7.7% because of the
rupee appreciation, and because of this it suffered a loss of around Rs 22
crores. Similarly, for Infosys, during the nine month period ended December 31,
2004 and for the fiscal 2004, the dollar denominated revenues represented 78.3%
and 84.9% of revenues. During the latest quarter ended December 31, 2004, the
rupee appreciated by 4.05% and this had an impact of 2.3% on its operating
income.

"If revenues are dollar denominated, mostly, and costs are incurred in
rupees, it is almost inescapable that the bottom-line will get impacted, other
things remaining the same. This was offset by hedging gains of 1.1% resulting in
net impact, to the bottom line, of 1.2%," says SL Narayanan, Corporate VP,
Finance, HCL Technologies. Priya Rohira, Research Analyst, Refco Securities
says, "It depends on the forex cover each of the IT companies have, and
that varies from company to company."

Speaking of dollars, every 1% gain in the rupee versus the dollar will see a
margin erosion of anywhere between 50 to 60 basis points. The important variable
in calculation of net impact of the currency movements is the currency mix of
revenue and the currency mix of expenses.

As various currencies have different correlations, impact on bottomline
depends on relative movements in various currencies. Exchange rate risk exposure
for Indian IT companies primarily arises from foreign currency revenues,
receivables and payables. The mix of various currencies in the revenue stream
and the currencies in which expenditure is denominated, determines the exchange
rate risk profile of companies and the sensitivity to appreciation of the rupee
vis-à-vis the dollar.

What next?

The first step is to get a fix on certainty of realizations, which is done
through a plan of booking forward contracts. These give an assurance on what
foreseeable rupee receipts can be, and consequently CFO's are able plan the
costs better. With the current bearish view on dollar, CFO's have taken such
forwards on most of net receipts expected in dollars, to the extent permitted by
exchange control regulations.

Secondly, software companies try to not time the market or do any panic sales
of future receivables. "We try to stagger our forward booking deals so that
there are no windfall gains or disastrous losses. This policy has stood the
company in good stead," says Narayanan.

The companies are gung ho about increasing hedging. As on 31 December, Satyam
had hedging of $150 mn that is now increased to $170 mn. "It is a
double-edged sword, if we cover too much now and if the rupee depreciates, then
it would be a problem later," says V Srinivas, CFO, Satyam. Similarly, TCS
is proactively hedging its exposures using foreign exchange derivatives market.
Infosys has sought to reduce the effect of exchange rate fluctuations on its
operating results by purchasing foreign exchange forward contracts to cover a
portion of outstanding accounts receivable. As of December 31, 2004, the company
had outstanding forward contracts of $309 mn.

Implications on future initiatives

Though rupee is appreciating slowly and steadily, the implications could be
rather quick. During late nineties, Indian software firms used to be almost 90%
dependent on US revenues. That number is now down to 60%-thanks to very rapid
growth in UK and other Western and European markets. Accordingly, billings in
pound sterling and euros have risen substantially in the last few years, as a
consequence.

Companies have also pursued other markets such as Japan and Australia to
diversify the risks of currency concentration. Of course, there are limits to
this principle, given the fact that the US, with a ten trillion dollar GDP,
would continue to influence the global economic outlook for a while.

Most of the software firms are planning to manage the exchange rate
fluctuations by using proactive hedging policy. "Company's future
initiatives won't be materially impacted by expectations of appreciation of
rupee. We ourselves have seen, in the last one year, sustained periods of rupee
appreciation and rupee depreciation. We need to manage in this environment so
that our net receipt in India is as per our plan," says Mahalingam.
"In a scenario where the appreciation takes place incrementally, within a
band, such appreciation will not have a material adverse impact on future
initiatives since our model provides us with flexibility to tackle it in terms
of variable compensation structure and scale benefits on the SG&A (Selling,
General and Administrative expenses) side," says Mohan Das Pai, CFO Infosys.

Though layoffs and salary cuts is not on the agenda for the short term but,
if the trend continues, it might affect employees in one way or the other.
"We do not anticipate any layoffs in the near term, given the enquiry
levels for new businesses and the rising interest in the India based offshore
delivery. There is certainly buoyancy in demand for trained people, which has
pushed up the salary levels, and we have to keep our compensation structures
comparable and benchmarked to the market," says Narayanan. Others are also
not looking at passing the burden on employees. "As mentioned earlier, the
appreciation of the rupee in a narrow band will not have a material adverse
impact. I would rule out salary cuts and employee layoffs for the larger IT
companies," says Pai.

The rupee movements continue to be a challenge for the Indian IT/BPO players.
Call it the downside of joining the global economy!

Rahul Gupta/CyberMedia News
Mumbai