scorecardresearchWhy the falling Rupee isn't benefiting the Indian IT sector
JP Morgan has downgraded the Indian IT services sector to 'underweight' and reduced several target prices by 10-20%.

Why the falling Rupee isn't benefiting the Indian IT sector

Updated: 20 May 2022, 03:53 PM IST
TL;DR.
The US market accounts for 40-78 per cent of revenues for Indian IT firms, with the big five – Tata Consultancy Services, Infosys, Wipro, HCL Technologies, and Tech Mahindra – accounting for more than half.

The Nifty IT index fell 5.74 per cent to 28352.15 points on Thursday, owing to recession fears, downgrades by JP Morgan and a sell-off in US markets. So far, the IT index has dropped 26% from a record high of 39,446.70.

In 2021, the Nifty IT index increased by 59 per cent, owing to substantial earnings growth for IT companies as a result of digital transformation transactions in the United States and Europe.

Meanwhile, the Indian IT industry is an export-oriented sector, which means that when the rupee falls, IT businesses benefit because it increases their profit margins. Big IT companies get a large portion of their revenue in dollars from US clients.

But that is not the case in the IT sector right now. The Rupee closed at a fresh all-time low of 77.73 versus the dollar on Thursday, the fifth record low close in the previous ten trading sessions.

The Rupee has depreciated 1.6 per cent in one month. During the same time period, the Nifty IT fell 9.7 per cent. This clearly tells us both are moving in a negative correlation, which means both are moving in the opposite direction. 
The Rupee has depreciated 1.6 per cent in one month. During the same time period, the Nifty IT fell 9.7 per cent. This clearly tells us both are moving in a negative correlation, which means both are moving in the opposite direction. 

So, why isn't the Indian IT sector benefiting from the rupee depreciation? The following are some key reasons:

Downgrades

JP Morgan has downgraded the Indian IT services sector to 'underweight' and reduced several target prices by 10-20%.

Indian IT growth was accelerating till the third quarter of 2022 and has begun to slow down from the fourth quarter, which is likely to worsen into FY23 from tougher comps, supply issues, and eventually a worsening macro. With peak sector growth behind, growth deceleration should continue to weigh on sector multiples, JP Morgan said.

Tata Consultancy Services, HCL Technology, Wipro, and L&T Technology have been downgraded from neutral to underweight, with target prices reduced by 15–21%.

CompaniesCurrent TP (Rs)Previous TP (Rs)
TCS3,1003,900
HCL Tech9501,150
Wipro430520
L&T Tech3,2004,500

Indian tech services are the most expensive service names globally, at a premium to digital native peers and Accenture, and at par with enterprise software that appears unsustainable. "Sector reverse DCFs suggest that the market is still baking in 6–13% growth for Tier 1s and 14–33% growth for midcaps over the next decade; that seems optimistic given that this remains a late cyclical sector for most names," according to the JP Morgan report.

However, the brokerage is overweight on Infosys, Mphasis, Persistent Systems and Tech Mahindra.

On the other hand, domestic brokerage firm Nirmal Bang Equities, too, has slashed both target PE multiples as well as FY24 earnings estimates for the sector amid margin concerns.

The brokerage firm believes that the sector's expected pain will be felt sooner in terms of valuation and earnings.

The deterioration in the profitability of the US corporate sector would result in reduced IT spending, and this is happening sooner than expected.

Concerns about a Recession

According to Goldman Sachs, there is a 30% chance that the US economy will enter a recession over the next two years as a result of the US Federal Reserve's aggressive interest rate hikes. Others, such as Well Fargo and Morgan Stanley, believe a recession in the US is around the corner as the Fed shows no signs of easing its fight against multi-decade high inflation.

Besides the US, the European market is also feared to be heading into a recession as the Ukraine-Russia war, soaring energy prices and prospects of higher interest rates push the EU to the brink of a recession over the next two years.

US Treasury Secretary Janet Yellen on May 18 claimed that while she sees no recession in the US, Europe is "more vulnerable" to falling into a recession due to the fallout of the sanctions on Russia following its invasion of Ukraine.

Major IT Companies- Revenue Distribution by Geograhpy (%) 4Q22                                   3Q22                                     
Company Name America Europe America Europe
TCS 53.3 31.1 52.4 31.6
Infosys 61.4 25.2 61.8 24.9
HCL 62.8 28.3 63.1 28.3
Wipro 59.3 29.3 58.6 29.7
Mindtree 76.6 15.7 73.0 18.6
Tech Mahindra 48.3 26.4 48.9 25.5
Source: Prabhudas Lilladher, Axis Securities, ICICI Direct Research    

The US market accounts for 40-78 per cent of revenues for Indian IT firms, with the big five – Tata Consultancy Services, Infosys, Wipro, HCL Technologies, and Tech Mahindra – accounting for more than half.

High Attrition Rate

According to media sources, the Indian IT industry is seeing a high attrition rate, which is averaging around 25 per cent. Companies are dealing with this situation differently and are bringing in measures to retain staff and high-potentials in particular.

IT companies are investing in salary corrections, attractive salaries and benefits, stock options, various employee engagement activities, and solid talent management practices. Market experts, however, feel this is a temporary phenomenon and may be contained over the next few quarters.

Industry experts said that the sharp rise in attrition rates has been fueled by the rising demand for automation and digitalisation across all industry sectors and the world at large.

Moreover, due to the record levels of attrition, India’s second-largest software services firm, Infosys, is reportedly invoking the non-compete clause in the employment agreements to curb attrition, Business Standard reported.

According to the agreement, an employee shall not accept for six months an employment offer from "named competitors" such as TCS, Wipro, and HCL Technologies, among others, if the new job involves working with a customer with whom the employee has worked in the preceding 12 months during his/her stint at Infosys.

The attrition rate at Infosys hit 27.7% for the quarter ended March 31, while the metric stood at 17.4% at bigger rival Tata Consultancy Services.

Further, market experts point out that the key to reducing the attrition rate in the Indian IT sector is to implement steps that are motivated to benefit the employees at a deep-rooted level that aim at contributing to their growth immediately and in the long run.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of MintGenie.

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