March 18, 2005

Dollar depreciation will stress test the Indian offshore model

Most of the Indian IT/ ITES companies have good margins and high return on capital. They quote a fairly high PE's.
If the reports are to be believed, a dollar depreciation is a high probability event. When will it happen and whether it would be rapid or slow and measured is the question. Most of the economist / financial commentators agree that dollar has only one direction to go in the long run and that is down. Now even the asian central bankers who are biggest buyers of US treasury seem to be acting on that.

Estimates show that a +1% appreciation of dollar would cause the margins to drop by 0.5 % ( or more ...i don't have the exact number ).

So hypothetically speaking if the appreciation is 10 % ( a probable outcome ) , then margins could drop by 5 - 10 %. Add to that wage inflation in india and increased competition , the Offshore business would come under severe stress.

This is not to say that the offshore trend will stop or the companies will go bankrupt or something, rather indian companies will have to learn to live with lower margins

This could see some weak companies getting washed out and the current darling could see their high multiples which the stock market gives them, being reduced.

So add a reduction in margins and drop in multiples and that gives you a picture of what could happen to the stock price.

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