Few factors shape the profitability of Indian software exporters as directly as the value of the rupee. These companies bill clients in foreign currencies but pay salaries, rent and most operating costs in rupees. When the domestic currency weakens, every unit of foreign revenue converts into more rupees, lifting reported profit. It is no surprise that the Infosys Share Price often responds to currency commentary during earnings season. Investors following the sector regularly discuss hedging policies as well. Meanwhile, anyone studying the TCS Share Price over a long horizon will find that currency effects, while important, are balanced by operational strengths.
Why a Weaker Rupee Helps
Because a majority of revenue comes from overseas clients, a depreciating rupee boosts revenues in rupee terms, without any change in business volume. Since the costs are largely domestic, this boost in revenue translates to huge gains to the bottom line, enhancing the margins.
This tailwind, however, is not perpetual. Hence, analysts have the practice of distinguishing between revenue growth due to demand and that due to currency. Constant currency reporting is done precisely for this purpose, and shrewd investors watch out for this.
The Role of Hedging
Companies do not leave currency exposure to chance. Hence, they use forward contracts and options to hedge against exchange rate fluctuations. This helps to smoothen out quarterly profits caused by such variations, and provides a clearer picture for management.
However, hedging has its own trade-offs. For instance, if the rupee depreciates post-hedging, the company does not benefit from the gains on account of hedging. However, if the rupee appreciates, it helps reduce loss on account of hedging. Gains and losses on these contracts appear on the income statement and hence investors need to read the fine print to find out if these are negative or positive for the stock.
Wage Inflation as a Counterweight
Gains on account of currency fluctuations can be negated by wage inflation. Indian IT firms have a competitive edge over other countries in the IT space, in terms of skill. However, salaries do rise in tune with demand and hence with higher attrition and retention bonuses, margins can erode in case of a stable rupee.
It becomes clear by now that the currency alone is not the sole deciding factor. There is a balance between the tailwinds and headwinds, which play a part. Hence, to take a call on whether profit margins expand or contract, it is vital to evaluate these factors together with the fundamentals.
Broader Economic Links
Currency trends often reflect inflation, interest rates, trade deficits or surpluses, and inflows and outflows of foreign capital. RBI’s policy decisions also impact the value of the rupee. Investors who track these indicators closely get an early indication of currency movement, which in turn points to exporters likely to benefit from such trends.
A Balanced Perspective
The rupee, as we see it, is just an enabler. Exporters with sustainable competitive advantages, superior workforces, enduring client relationships, and deep delivery capabilities benefit more from such trends. It is important to treat currency as a supplement and study the hedging practices followed by companies on a quarterly basis. Above all, it is vital to focus on the company and its operations.
