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Rupee appreciation and profit margins

Discussion in 'Money Matters' started by pammor, Nov 11, 2007.

  1. pammor

    pammor Senior IL'ite

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    Amajor cause for worry for the Reserve Bank of India (RBI) and exporters has been the appreciation of the rupee against the dollar. Usually, it used to be the other way. But of late, the rupee has been getting stronger and the dollar has been weakening. Why is the dollar weakening? There are various factors responsible.

    The rupee's gains have been mostly on account of continued capital inflows into the country. A slowdown in the US economy is one major factor. The other was the sub-prime issue. Recently, the US Fed has cut down interest rates. It cut US short-term interest rates on October 31.

    This was a widely anticipated move, because it had acted amid concerns that economic growth will slow down in the coming months. The US Federal Reserve has lowered the federal funds rate by 25 basis points to 4.5 percent. The discount rate has also been cut by a quarter-point to five percent in an effort to stimulate economic activity and keep the country from dipping into a recession.

    The Federal Open Market Committee (FOMC) also warned that higher energy and commodity prices may spur inflation and the pace of economic expansion is likely to slow down in nearterm. The Fed had unexpectedly slashed borrowing costs on September 18 by half a percentage point. The concerns over housing and credit seem to be dominant.

    The Fed had reduced rates in an effort to keep the world's largest economy growing at a 'moderate' pace and avoid a recession. The dollar's decline on foreign exchange markets makes foreign goods and products, particularly oil, more expensive. The RBI has said that inflows from abroad accelerated after the Federal Reserve lowered rates.

    According to the RBI, there is excess liquidity in the system. This is mainly because of strong inflows of foreign funds into India. With huge inflows of dollars, the rupee has been getting stronger against the dollar. Foreign investors have helped Indian stocks go up. The US Federal Reserve rate cut is a major boost for the Indian stock markets. The foreign fund inflows may increase. A stronger rupee eventually means Indian goods and services will be less competitive in the main export markets.

    India's exports to the US are mostly labour-intensive and especially so in respect of business process outsourcing. The impact of the rupee appreciation can hit the thin profit margins of BPOs. Exporters who are uncovered are losing because of the rupee appreciation. Exporters need to keep their receivables hedged. With the increase in foreign funds, the dollar would further depreciate against the rupee. The rupee appreciation affects the exportoriented companies and companies having mainly overseas revenues.

    These include IT companies, technology stocks and so on. Although their revenues are increasing, the net realisation and profit margins are being adversely impacted because of dollar depreciation. With margins being eroded, the stock prices of these companies are also adversely affected.
    IT industry is particularly impacted because most of their clients and billings are US dollar denominated. At the same time the import intensive industries benefit by the rupee appreciation. They now need to pay lesser dollars than before to import their equipment and raw materials.

    This in turn improves their bottom lines. This applies to industries like capital goods industries. As a result, the stocks of such companies see an upswing. Global commodity companies price their products on landed costs. With a decrease in landed costs, profits for these companies will be hit. Software companies are also going to lose on the back of the appreciating rupee as their exports are priced in US dollars.

    On the other hand, sectors that are likely to gain from the currency gaining are auto, engineering and aviation, as the price of their imported raw materials will cost less. Engineering companies gain on raw material cost savings. Companies with foreign currency loans are also likely to gain due to rupee appreciation. <!--google_ad_region_end=article--><SCRIPT type=text/javascript> var RN = new String (Math.random()); var RNS = RN.substring (2,11); b2 = '<iframe align="left" src=""\"http://adstil.indiatimes.com/RealMedia/ads/adstream_sx.ads/www.economictimes.com/Stories/index.html/1'+RNS+'@Right3?\" WIDTH=255 HEIGHT=250 marginwidth=0 marginheight=0 hspace=0 vspace=0 frameborder=0 scrolling=no bordercolor=\"#000000\"> </iframe>'; if (doweshowbellyad==1) bellyad.innerHTML = b2; </SCRIPT>


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