Consulting|Technology|International business

Rising rupee / Foreign exchange exposure of Indian IT companies due to appreciation

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Cross posted in

In the last few weeks, we have been hearing of the top Indian IT service export companies declaring their Q1 results (remember the Indian financial year is from Apr 1st – Mar 31st) and almost all of them without doubt have been hit by a rising rupee. I have written an earlier post on the same topic and it made for interesting analysis back then –

I read in the papers today about some steps taken by some of these IT majors such as asking employees to work on Saturdays to compensate for their exposure to the rupee appreciation! I am not so concerned about the fact that they are asking their people to work on Saturdays but I am concerned about the fact that they are trying to relate two different events (from an employee perspective in an employee driven organization) to justify their need to make employees work on Saturdays to cover for their risk exposure to the outside forex market. Is this justified – is what I am trying to analyze.

As a qualified student from India’s most prestigious institute in foreign trade, IIFT, New Delhi, I make these comments.

First of all, before getting into slam-dunking anybody, let us examine the rationale and what are the possible options for these IT bigwigs to limit their exposure to this Forex exposure and later, we will visit the upper end of the supply chain impact and its ramifications.

The foreign exchange market is a trillion $ market and is the largest financial market of all –

This market is 5% operated by Governments/banks/companies and 95% by speculators looking to make a quick buck/profit depending on the currency fluctuations and is also very tightly regulated to minimize arbitrage opportunities. Unlike stock market, here there are no brokers or intermediaries – the buyers and sellers come together at an agreed price and this market also is the only market that runs 24 hours due to the geographic distribution ex: different timezones.

It also has to be remembered that the world of currency market is a zero sum game – this means somebody’s loss is somebody’s gain. A very interesting article on currency markets being treated as a zero sum game (copyright vested with the author quoted on the document) can be found here –

The currencies of almost all countries fluctuate on a daily basis and this is not some rocket science phenomenon. Why this becomes so important for Indian exporters (not necessarily only IT) is because the invoice currency of most of these companies is in USD (US Dollars). This means, they bill their customers in USD. Therefore, if they make exports worth 100$ and the value of the rupee on the forex market is say Rs. 47 to a US Dollar, they stand to make Rs. 4700. However, if the value of the rupee appreciates vis-a-vis the USD (like it is doing now), these very exports of good/services would fetch these export companies that much lesser. ex: if the rupee appreciates or the USD declines to say 1$ = Rs. 40, then these  export companies would make only Rs. 4000 – this has a direct impact on their revenues and therefore, their bottom line.

To prevent such oscillations in their net earnings companies follow a very simple concept of hedging (to hedge their exports) using a number of financial instruments available to them such as Forward exchange contracts, options etc.

On forward exchange contracts, exporters basically book their export orders at a pre-set dollar price (say 1$ = Rs. 46.30 or something) by buying a forward exchange contract. There are various types of this forward exchange contracts also such as rollover forward exchange contract etc. but we will not get into their intricacies here – the overall concept should suffice.

How does this work?

Forward exchange contracts need to be purchased at a predetermined levels. If the forward exchange price is trading at below the spot price, then it is said to be at a discount while if it is trading at more than the spot price, then the currency is said to be at a premium.

Forward exchange contracts have no major advantage to aid the company for favorable currency movements (ex: INR depreciating against the USD in which case the exporters whose invoice currency is in USD will stand to benefit because they get more INR for each USD) but they do eliminate the downside risk because no matter what, the company can claim against that contractual price for the total  exposure thereby limiting the risk.

Accounting for this forward exchange contract has been discussed at this link:

Now, having understood what this market is all about, why hedging is required and how does this hedging work, let us look into the forex exposure of Indian IT bellwethers and put some numbers to the analysis to get an idea of their risk exposure and how they have tried to minimize the risk.

All data has been collated from respective annual reports of respective corporations. A source would have been indicated too.

Infosys states (on its Annual report 2006 – 2007) that it has outstanding forward contracts of $ 170, 000, 000 as of March 31st 2007 when compared to $ 117, 000, 000 as of March 31st 2006. It has 2, 000, 000 Euro which was not there in 2006, and 5, 500, 000 British Pound Sterling as of the same March 31st 2007 – again, this was not there in 2006.

Just goes to show the increase in the amount of forward contracts outstanding and this time, purchased over a basket of currencies with who Infosys does a majority of their business with. My guess is they might even purchase some forward contracts on the Japanese Yen with the increasing business they do in the APAC region next year! This is pure speculation though.

Infosys also uses derivatives such as options (options contracts outstanding). Last year, they had put options worth US $ 4, 000, 000 but not this year. Same with a Common strike ratio option they had last year of US $ 8, 000, 000. However, this year, they have gone in for a range barrier option of US $ 206, 500, 000 this year as compared to last year’s US $ 210, 000, 000. They also have a Euro accelerator option of $ 24, 000, 000 this year as compared to UD $ 3, 000, 000 last year. In addition to this, they have a target redemption structure of GBP 16, 000, 000 this year as opposed to GBP 3, 000, 000 last year. Also, they have a range barrier option of GBP 8, 250, 000 this year which they did not have last year.

All data indicated above has been taken from the Annual report of Infosys technologies (AR 2006 – 07) available for a free download from their website at this link:

What does this trend indicate? For one, it does show that the companies are limiting their exposure with the number of forward contracts booked and the diversity in the types of options purchased to hedge their exposure in currencies of regions where they tend to export.

Now, that we have looked at the level of exposure etc. and the outstanding forward contracts companies have (one example given above), let us look at how these companies operate (their primary business model).

Consultancy companies typically bill people on a per hour per billable person basis to a client. ex: if Infosys has a billing rate of say (hypothetical) USD 100 per hour per person, then for 100 people working on a project, this means they bill their customer (XYZ), USD 10000 per day.

If the exchange rate is 1 USD = Rs. 47, Infosys would’ve made Rs. 47 * 10000 = Rs 4, 70, 000 for that day. Assuming, the foreign exchange rate fluctuates and now the rate stands at 1 USD = Rs. 40, Infosys earns only Rs. 40 * 10000 = Rs. 4, 00, 000 (Rs. 70K lesser for every day).

Furthermore, onsite billing rates are much higher when compared to offshore rates.

Did these companies consider giving free time to their employees when the INR was depreciating? No. But, now, they want to make the same employees work on Saturdays to offset this rupee rise. This is not fair – in my opinion. No company has a control on the currency markets and they have to improve their productivity if they have to withstand this challenge. How will increased producitivity offset this currency rise – you might ask? The answer is simple: If the companies increase their utilization rates of employees, producitivity is enhanced. How is utilization rate measured? Get more people off from the bench and onto productive projects. As long as one is on ‘bench’, one is not billed. Get this number to as minimal a number as possible. Improve supply chain efficiency by adhering to better forecasts of when to hire and when to hold. Another is to increase # of workhours per week so people are utilized better but this has a split side -would those increased hours be billable? If so, would it be okay with the client as the client has to pay for the increased hours of service of employee of these firms per week.

Another way to improve utilization rate is to improve efficiency and eliminate redundancy. This is where Toyota is so efficient in its capacity utilization while GM lags behind though GM has done better this year. Capacity utilization is also to ensure that plants keep running are are utilized optimally while employee utilization is where employees are most productive and are utilized efficiently.

Indian IT firms would need to go back to these basic micro economic concepts if they are to withstand the INR appreciating onslought! The answer is not simply in increasing # of work hours per week – it has to be said. They need to look elsewhere too.


10 Responses

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  1. Very informative. Keep this kinda stuff going mate!


    July 20, 2007 at 12:58 am

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    August 13, 2007 at 4:38 pm

  3. very very helpful… keep going


    August 30, 2007 at 9:24 am

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    October 11, 2007 at 4:14 pm

  5. very helpful…superb


    October 15, 2007 at 1:38 pm

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