In the past, India’s information technology (IT) services companies—which get most of their revenue from exports—have typically celebrated the slightest depreciation in the rupee against the dollar.
Every 1% movement in the rupee against the dollar impacts operating profit margins of Indian IT services companies by between 25 and 40 basis points.
But the rupee’s recent slide has prompted little joy. The rupee has dropped by around 4%—hitting its lowest level against the dollar in nearly two years—since China devalued the yuan on Aug. 11.
Instead, the country’s IT services sector is afraid that the meltdown in China—a huge contributor to the global growth—may lead to a slump in major markets like the US and the UK. Some observers have reckoned that the Chinese stock market crash could be the beginning of a global recession.
“China has sneezed, and we don’t know whether this is just an allergy, a viral infection or something more serious. Plus, this patient is very secretive, so we don’t know much about its medical history,” Rostow Ravanan, executive director and former CFO at Mindtree, a mid-sized IT services firm, told Quartz. “Only God knows what’s going to happen.”
While China directly comprises less than 5% of revenues for most Indian IT services companies, the sector could suffer a severe blow if clients in key regions like the US and the UK start trimming their technology budgets.
In an Aug. 27 report, Japanese brokerage firm, Nomura noted that “growth impacts of recent global events cannot be ruled out. Any adverse impacts on the developed market demand (especially in the US) due to recent developments need to be watched.” Indian IT services companies were hit hard during the 2008 global financial slowdown, and the sector still hasn’t entirely recovered from the shock.
On Aug. 25, the S&P BSE information technology index was the only one among the 12 sectoral indices to end in the red, when most stocks recovered from the previous day’s dramatic fall—dubbed Black Monday. On Aug. 26 again, the IT index closed nearly 1% lower.
Rattled rupee
There is also concern that the rupee may remain volatile for some time, which would reduce predictability for these businesses in the near term.
“Depreciation helps, but over the last two years, we have seen that many times when rupee depreciates, it recovers soon and then even appreciates. That kind of fluctuation is not good for any IT services company,” Arup Roy, research director at Gartner, explained. “Even though IT services companies will try to protect themselves by hedging, sometimes the volatility can lead to a notional or even real loss.”
Rajiv Bansal, chief financial officer at Infosys—India’s second largest IT services company—also argues that the fall in the rupee won’t be of much help. ”Any benefits from depreciation in currency in the long term has to be passed on to clients. So the recent weakness may help for a quarter or two, but eventually it won’t matter much,” Bansal told Quartz.
Bansal, however, does not expect any fall in spending by his clients due to the recent developments in China. “Clients may have some issues in the short-term,” he explained, “but global companies know about their exposure to China well, and they will balance it out, I am sure.”
But earlier this week, Ruchir Sharma, head of emerging markets and global macro at Morgan Stanley Investment Management, clearly outlined the persisting risks. ”The world is one shock away from recession,” Sharma wrote in the Wall Street Journal. “A debt-laden China is now the critical link, and another one- or two-percentage point decline in its growth rate could provide that shock.”