Rupee's Margin Call

The ongoing slide in the Indian rupee is expected to be a two-fold blow for companies that draw a major chunk of their revenues from exports. Lower demand is likely to follow a decline in the value of the Indian rupee since most developed economies fear a severe slowdown in growth that might affect the profits of IT companies and auto exporters.

A significant portion of the revenues of Indian IT, pharmaceutical, and specific car accessory firms are made in US dollars. These businesses typically experience an increase in margins with currency devaluation. “Rupee depreciation has been generally beneficial for exporters, including IT services firms, pharma firms, textiles, and auto exporters. Generally, most firms in these sectors hedge at least part of their exposure, so the benefits of the rupee depreciation should accrue after two quarters of depreciation,” says Nishit Master to Forbes India, portfolio manager, Axis Securities PMS. However, he adds that this time around the rupee depreciation is expected to be followed by lower demand, with developed economies looking at a slowdown in growth.

Due to a high US dollar index, which has been boosted by aggressive tightening by the US Federal Reserve to control inflation amid rising indicators of an imminent recession, the Indian rupee and other emerging market currencies have been on a precarious slope for the past few months. The depreciating rupee has also been linked to rising commodity prices. Only commodity-linked, high-yielding emerging currencies have seen gains this year, including the Brazilian real, Mexican peso, and Russian rouble.

Margin Call amidst forex fluctuations

The fund manager of Coffee Can PMS, Ambit Asset Management, opines that rupee depreciation is beneficial for the margins of some export-oriented sectors like IT services, auto, and pharma. However, the negative effects of two factors—namely, the slowing of growth as a result of the imminent recession in the United States and the European Union, where demand and expenditure are falling, and the strengthening of the rupee versus the euro and the British pound—dampen the mood. “This means that even for export-oriented companies, the positive impact shall be largely limited, which is reflected in limited excitement in the markets. Over the medium term, we expect things to settle down as India remains on strong footing and the US should recover soon enough. We would maintain our positive stance on IT services and auto,” says Jain.

Not just in emerging countries like India, but all throughout the world, currency fluctuations have been a key source of concern, mostly due to US Fed tightening. Although the Reserve Bank of India (RBI) has done a great job of controlling both inflation and the rupee, there isn't much more room for manoeuvre. Markets won't be shocked, according to Jain, if the rupee reaches 85 versus the dollar soon.

Rupee on the ice might hurt business margins. Experts predict that enterprises serving European markets in the car, IT, and pharmaceutical industries may suffer as a result of the projected severe recession in Europe. “With the rupee appreciating against the euro, these companies will face a double whammy, since on the currency front also they are not well placed if they bill their revenues in euros,” says Master.

Principally, companies that rely on imports for revenues get bulldozed by rupee depreciation. “Typically, oil market companies are the ones to get directly impacted by rupee depreciation, especially if they are not able to pass on the complete price increase to their clients. Fertiliser companies importing urea for the domestic market could get impacted due to higher working capital requirements. Cement companies also get indirectly hit due to rupee depreciation as fuel cost for them is dependent on the USD/INR rate,” says Jain.

Despite a larger likelihood of recession in important European countries and an energy crisis, prominent Indian IT businesses' September-quarter earnings analysis reveals that revenue growth in Europe on a constant currency basis is still strong. Kotak Institutional Equities Research says “The US dollar growth has been impacted by cross-currency headwinds. Companies are watchful of developments in the region". The agency added that companies may have to scope out price increases, which is challenging in existing businesses but possible in new contracts.

For FY2023, Infosys kept its forecast for revenue growth rise of 14 to 16 percent in constant currency. HCL Tech revised its forecast for revenue growth in FY2023 from 12 to 14 percent to 13.5 to 14.5 percent in constant currency. In the quarter ending in December 2022, Wipro projected quarterly growth of between 0.5 and 2 percent in constant currency. The rupee lost value against the US dollar by 3.6 percent for the quarter, but it gained value against the British pound, the euro, and the Australian currency by 1 to 5 percent.

Indian rupee versus other currencies

The Indian rupee has lost 10% of its value in 2022 thus far, falling to a low of 83.29 against the US dollar on October 20. This comes after the rupee's gradual devaluation over the previous few years. The rupee depreciated by 1.5 percent in 2021; over 2 percent in both 2019 and 2020; and 8.6 percent in 2018. Major currencies including the pound, euro, and yen have all had considerable losses against the dollar so far in 2022: The euro has decreased by 12.63 percent, the pound by 14.68 percent, and the yen by 22%.

The dollar index, on the other hand, has been strengthening. It increased by 7 percent the year before, then by 16 percent this year, after falling by 7.3 percent the year before.

In comparison to the group of developing markets, the depreciation of low-yielding currencies against the US dollar has been rather significant. The rupee is fairly positioned among peers despite not being a commodity-linked currency, according to experts, because external vulnerability measurements have significantly improved.

In a monthly review report, Tirthankar Patnaik, Chief Economist, National Stock Exchange of India, said, “History suggests that the spill-over effects of a recession in the US and Eurozone invariably result in growth slowdown in the economies that have close trade and financial linkages with them. India is unlikely to remain immune, as also seen during past recessions. On balance, an unfavourable global backdrop in the wake of monetary tightening, geopolitical tensions, and Chinese slowdown is likely to weigh on domestic growth via the trade channel and through foreign capital flows". 

According to Patnaik, increased input costs would have an impact on discretionary spending. 

Better corporate and bank balance sheets are encouraging for the present private investment rebound, but weaker global demand, low consumer sentiment, rising rates, and pressure on margins are most likely to function as major roadblocks.