India's Rising Rupee Bedevils Outsourcers

On top of surging wages and ferocious competition for talent, a turbocharged currency is adding to Indian outsourcers' earnings pressure

The Indian rupee seems to be on steroids this year. On Apr. 24, the currency surged to 41.14 to the U.S. dollar, its highest rate in nine years. In just the past six months, the rupee has appreciated 8.4% against the dollar, and economists predict the Indian currency will be even stronger in coming months.

That's cause for concern in the country's crucial $8 billion outsourcing sector. The U.S. is the biggest market for most Indian infotech companies, accounting for over half of the revenues this industry generates by handling back-office and other operations. So the rising rupee is putting a squeeze on earnings—cutting margins by about 2.5 percentage points since mid-2006.

Says Raman Roy, the pioneer of India's outsourcing industry, and head of outsourcing firm Quatrro BPO Solutions, "The only thing is to work around the strength of the rupee, as cost reduction is only an outcome of good management."

"Obviously it is hurting all of us," adds Sethuraman Mahalingam, chief financial officer of Tata Consultancy Services (TCS). For the fiscal year ended in March, 2007, TCS' operating margin was 25%, compared to 25.5% for the year before. That's scaring investors. Since Apr. 13, when outsourcing giant Infosys announced its results, the IT Index on the Bombay Stock Exchange has fallen by 0.17% even as the overall market index rose 4%. Infosys' stock received a 2% haircut on Apr. 24 and finished trading at $50.

Constraints to Growth

The muscular rupee is adding to competitive pressures already being felt by the outsourcing industry. Wage costs have been on the rise by 15% thanks to stiff competition for talent among tech companies such as IBM (IBM), Accenture (ACN), and EDS (EDS). For instance, IBM has more than doubled its India staff to 53,000, has spent $2 billion there since 2004, and plans to spend another $6 billion by 2009.

And by this August, Accenture is expected to have 35,000 of its 160,000 employees in India (see, 4/17/07, "Are Indian Outsourcers Losing Their Edge?"). "The skills problem is now the single most important constraint to growth [in India] and an appreciating rupee simply adds to that," says Sanjeev Sanyal, senior economist at Deutsche Bank in Hong Kong.

What's pushing the rupee upward? Foreign investment has been pouring into India. Since January alone, institutional investors have pumped $2.5 billion into Indian capital markets. At the same time, the Reserve Bank of India has been trying to dampen India's 6.07% inflation, and has raised interest rates five times in past 12 months.

The central bank also hiked the cash reserve ratio—the amount that banks have to deposit with it—three times since December. Over the same period, India's foreign exchange reserves have surged by 25% to more than $200 billion.

Finding New Ways to Hedge

To keep the strengthening rupee from taking too much of a bite, Indian IT companies have been hedging against their currency risk. For the first three months of this year, Wipro hedged $600 million while TCS hedged nearly $1 billion and Infosys $470 million. At the same time companies have also tried to expand their customer base beyond the U.S.

Last fiscal year, 52% of TCS' $4 billion in revenues came from the U.S. That's down from 59.5% two years ago as it has expanded into Europe, China, and Australia. Meanwhile Wipro today gets 32% of its sales from the euro zone vs. 62% from the U.S. While the rupee has also strengthened against the euro, yen, and Singapore dollar, the gain is less than against the U.S. dollar.

How long will the strong rupee add to outsourcers' problems? Probably for at least three to six months, economists say, if the Reserve Bank of India keeps hiking rates to curb inflation. That will put more pressure on India's powerful infotech companies to find new ways to hedge their risk and contain rising costs.

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