IFM

Impact of currency fluctuation on IT industry

Group No 34 Anu Kannan (SMS ID: 2217679) Mohanprasad T (SMS ID: PGCBM18, 2217345)
Guided by Dr. H.K.Pradhan For PROJECT

XLRI, Jamshedpur.

Introduction
This paper attempts to analyses the impacts of rupee fluctuation against US dollar in 2008-2009 time frames on IT companies. The paper also briefly looks into the measures taken by the IT companies to insulate themselves from the fluctuations. In recent years, the value of the U.S. dollar has experienced historical highs followed by a dramatic decline against the currencies of Americas major trading partners like India, a trend likely to continue. Meanwhile, many U.S. companies have moved substantial portions of their operations overseas in order to lower costs and improve profitability. With revenues denominated in U.S. dollars and costs denominated in other currencies, any long-term decline of the U.S. dollar poses a significant risk to profits, competitive positions, cash flows, and ultimately share value. In particular, the significant role of India in many corporate IT Services and the potential appreciation of the Indian currency together pose a high degree of risk to U.S. importers. Financial hedging tools are typically insufficient or too expensive to address large and long-term exchange rate shifts. The momentum of global macroeconomic forces and the increasing U.S. trade imbalance suggest long-term devaluation of the U.S. dollar. This has significant implications for IT companies with international Demand for IT Services and markets. Recognizing and preparing for these implications now could mean the difference between success and failure in the future.

Indian Exchange Rate System

Aftermath of a balance of payments crisis in 1991, changes to monetary policy framework was undertaken to bring about stabilization in the Indian economy. India adopted market-determined exchange rate system in Mach 1993. This transformation enabled widening of the Indian foreign exchange market. Since the mid-1990s banks and corporates have been given the flexibility to use various derivative products for hedging risks and asset-liability management purposes.

Indian IT Sector
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The growth of post-liberalized India has been contributed majorly by the growth of the Service industry which includes the sectors like IT, BPO, Health etc. The service industry has been growing at a greater rate when compared with the manufacturing and agriculture sectors. As per government statistics, the entire services industry has contributed around 69% of overall growth in GDP between the periods of 2002-2007. The Information Technology sector together with ITeS (IT Enabled Services) which are part of the service industry provides a major thrust to the economic growth of the overall country. This sector has contributed around 5 -6 % of overall GDP growth for the period of2006-08. IT industry mainly focuses on providing IT and IT based services to the international corporations and governments. customers. As per NASSCOM, during FY 2011, revenues from the service exports are estimated to have aggregated to USD 59 billion, which contributed to 26% to total Indian exports. This clearly indicates that many of the leading IT organizations in India get their revenue in terms of USD , thus making them vulnerable to exchange rate risks. Only less than 10% of the industrys services are focused on Indian customer base. So, the major portion of its revenues comes from US

Kinds of Foreign Exchange Exposure:

Translation exposure or Accounting exposure is the risk that a companys equities, assets, liabilities or income will change in value as a result of exchange rate changes. This occurs when a firm denominates a portion of its equities, assets, liabilities or income in a foreign currency. Translation exposure to IT companies result from the need to restate the foreign subsidiaries financial statements into the parents currency. Economic exposure is an exposure to fluctuating exchange rates, which affects the companys earnings, cash flow and foreign investments. It is the extent to which a firms market value, in any particular currency is sensitive to unexpected changes in foreign currency.

Transaction exposure is a form of short term economic exposure due to fixed price contracting in an atmosphere of exchange rate volatility. Currency fluctuations affect the value of the firms operating cash flows, income statement and competitive position and consequently market share and stock price.

Volatility of INR - USD Exchange Rate.

INR USD is one of the important indicators of investor sentiment which has an impact in the performance of various sectors as well as government. In the Managed Float Exchange Rate System which is followed in India, the exchange rate of INR-USD is being influenced by almost all of the factors given by theory such as Inflation, Income rate, Interest rate, expectations as well as Government Policies. Considered as one of the investment indicators, government regularly have a close watch on the INR-USD exchange rate and also frequently tries to influence the exchange rate by both sterilized as well as non-sterilized intervention. Indian government tries to lock-in the exchange rate within a specific range for a period of time. For example, as per recent news, the Indian government looks forward to control the exchange rate in the range of Rs.44-46 for a next 6-12 month period. Similarly, the Indian government based on the macro-economic conditions look forward to have an influence on this INRUSD exchange rate.

Fig 1.0 Monthly Average Forex Rates (INR US$)

The INR-USD Forex rate has drastic fluctuation in 2007-2010 periods. The Indian rupee started 2007 at Rs. 44 and steadily appreciated throughout the year close at Rs.39 to

the dollar in Dec 2007. Most Indian exporters had not anticipated that rupee would strengthen by 11% and their bottom lines were adversely affected. Firms operating in the information technology and outsourcing sectors were driven by the margin protection as more than 90% of their revenues are dollar-denominated. These companies were feeling vulnerable after the rupee appreciation they had witnessed in 2007 and, in response, aggressively hedged their future cash flows. The idea that it could dramatically depreciate was not really on their radar screens. By Mid-2008 the rupee had fallen to Rs.52 to the dollar, which makes a drop of 40% Corporate India's fiscal 2009 results show that local companies have lost hundreds of millions of dollars from bad currency hedgesand in some instances this has wiped out their entire profit

Measures Taken By the IT Organizations

Some of the widely used techniques adapted by these organizations are as follows. The following are the hedging mechanisms have been adopted by IT majors such as TCS, Infosys. Future Contracts Currency options

The companies like Wipro majorly use Cross Currency Swaps to hedge against the exchange rate variations. Hedging: Based on the limits a firm set for itself to manage exposure, the firms then decides an appropriate hedging strategy. There are various financial instruments available for the firm to choose from: futures, forwards, options and swaps and issue of foreign debt

Hedging Instruments:
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A derivative is a financial contract whose value is derived from the value of some other financial asset, such as a stock price, a commodity price, an exchange rate, an interest rate, or even an index of prices. The main role of derivatives is that they reallocate risk among financial market participants, help to make financial markets more complete.

Forwards: A forward is a made-to-measure agreement between two parties to buy/sell a specified amount of a currency at a specified rate on a particular date in the future. The depreciation of the receivable currency is hedged against by selling a currency forward. If the risk is that of a currency appreciation (if the firm has to buy that currency in future say for import), it can hedge by buying the currency forward. The main advantage of a forward is that it can be tailored to the specific needs of the firm and an exact hedge can be obtained. On the downside, these contracts are not marketable, they cant be sold to another party when they are no longer required and are binding. Futures: A futures contract is similar to the forward contract but is more liquid because it is traded in an organized exchange i.e. the futures market. Depreciation of a currency can be hedged by selling futures and appreciation can be hedged by buying futures. Options: A currency Option is a contract giving the right, not the obligation, to buy or sell a specific quantity of one foreign currency in exchange for another at a fixed price; called the Exercise Price or Strike Price. The fixed nature of the exercise price reduces the uncertainty of exchange rate changes and limits the losses of open currency positions. Options are particularly suited as a hedging tool for contingent cash flows, as is the case in bidding processes. Call Options are used if the risk is an upward trend in price (of the currency), while Put Options are used if the risk is a downward trend. Swaps: A swap is a foreign currency contract whereby the buyer and seller exchange equal initial principal amounts of two different currencies at the spot rate. The buyer and seller exchange fixed or floating rate interest payments in their respective swapped currencies over the term of the contract. At maturity, the principal amount is effectively re-swapped at a predetermined exchange rate so that the parties end up with their original currencies. The advantages of swaps are that firms with limited appetite for exchange rate risk may move to a partially or completely hedged position through the mechanism of foreign currency swaps, while leaving the underlying borrowing intact. Apart from covering the exchange rate risk, swaps also allow firms to hedge the floating interest rate risk. Cross-currency swap: An agreement between two parties to exchange interest payments and principal on loans denominated in two different currencies. In a cross currency swap, a loan's interest 8

payments and principal in one currency would be exchanged for an equally valued loan and interest payments in a different currency.

INFOSYS, a case
INFOSYS

We hedge our forex risk by proactively hedging forex denominated receivables. As of March 31, 2007, we had US $179 million (Rs.770 crore) of forward contracts and US $ 269 million (Rs.1158 crore) of options contracts outstanding. Our forward and option contracts for the year ended 31st Mar 2007 and 2006 were not designated as effective hedges. Forward and option contracts not designated as effective hedges are marked to their current market value as at the balance sheet date and accounted in the profit and loss account for the period. The details of the foreign exchange gain (/losses) are as follows:

2008

2009

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