The Rising Rupee-Dollar Ratio

by Krishna on August 12, 2007

I recently received an email article entitled “Stronger Rupee, Stronger India”. The essay was about the appreciation of the Indian Rupee against the US Dollar since the beginning of the year. The author’s argument was that a stronger rupee was better for India as it would make Indians less dependent on getting low-cost IT service business and force Indians to come up with innovative products.

Although I don’t want to operate as an economist without a license :-), I am not sure whether a stronger rupee is good for the country. There is evidence to the contrary with countries such as Japan and South Korea having worse exchange rates. A country like China keeps its currency pegged against the Dollar to avoid losing its cost-advantage.

A stronger rupee necessarily means more imports and less exports – whether that is good for India in the long run is debatable. The IT industry is a very small portion of the economic output in India, i.e., only 1% of the total GDP. And India has a large industrial and agricultural base, which could be affected by the rupee appreciation.

I do know something about the short-term impact on IT outsourcing to India, so let’s discuss that. Since the beginning of 2007, the Indian Rupee has gone from Rs. 45 against the dollar down to Rs. 40 (roughly). During the same period, salaries have sky-rocketed in India, while at the same time, there has been increasing competition from East European and other Asian countries.

This situation has led to diminishing profits in the IT outsourcing industry. The outsourced work still exists and continues to grow, but since it is primarily a service industry, the margins are becoming smaller. So while business and revenues are likely to increase, the profits will slowly hit a plateau. Such a situation is normal and expected in any fast growing industry.

The higher margins until recently had allowed vendors to maintain high bench strength and invest heavily in training, processes and infrastructure, among other things. All of these could come under pressure. Smaller vendors, caught between stagnant market rates and rising labor costs, will find it increasingly difficult to manage future growth. This will have negative effects on the Indian IT labor force.

At some point in the near future, rising salaries will hit a ceiling beyond which it is economically unfeasible to conduct outsourcing operations. Remember that outsourcing (or for that matter, any geographically disbursed development) includes several types of overhead costs both for the customer and the vendor. This means that future salary growth will be less spectacular. Highly salaried professionals will be under greater pressure to prove their value and they must, therefore, put greater efforts to maintain their advantage.

Right now, there is a big recruiting rush for software developers. And companies are not really looking carefully at the right mix of resources in terms of different levels of experience and skills. Companies are willing to pay handsomely for any person with a reasonable resume. This is due for a correction.

Companies will have to take stock and put the right mix of experienced and freshmen developers. They will have to spend more to retain such people and train them. This will mean operating lean and paying significantly more attention to resource management and allocation. Overall employment will decrease (or not increase as much) as companies learn to do more with less people.

In recent times, there has been much trickle-down of wealth because of heavy spending by highly paid software professionals – real estate, electronics, automobiles, etc. Some real estate prices have gone up several times. Much of this is speculation because such prices can only be afforded by commercial entities and not by most Indians, who outside IT, still continue to have low salaries.

If the IT industry slows, this could have the effect of slowing down such spending. Some of the corrections in the prices of high-selling goods and services could affect those sectors. In the long run, this could all even out and the economy will be stronger. But in the meantime, a lot of people stand to lose a lot of money.

But what about Indian product innovation? More in my next article…

{ 5 comments }

Chris August 13, 2007 at 3:25 am

This type of business training will deal on the known factors of a specific job. Specialist instructors or supervisors commonly give this type of training either within the “working hours” or “in-house” training. …

Alexey Linkov August 14, 2007 at 11:39 am

i think the rise of rupee is quite a natural process and has nothing to do with the shift from basic programming services and BPO to innovation and R&D outsourcing. In the end, only those companies that strive to reach maturity and process excellence in outsourcing (both buyers and providers) will be able to source innovation.

Krishna Kumar August 14, 2007 at 12:24 pm

Alexey, I agree with you. The Rupee rise does not mean automatically improving innovation. However, it does affect outsourcing vendors to some extent. Only the ones with better processes and management will be able to survive in the increasingly competitive environment.

anil August 15, 2007 at 10:52 am

About the rising Rupee, what is your forecast in the next 3-5 years? I have this property in India that I am paying a mortgage on. I am debating whether to pay it off or keep the loan. My instinct tells me that a ratio of 40:1 does not reflect the true value of the rupee, but I have no economic or business background.

Krishna August 15, 2007 at 8:38 pm

Anil, I don’t think the rupee can or will be allowed to increase beyond a limit, because that can upset exports to a high degree. In India’s case, exports seem to be the major source of foreign exchange. Since the 5 rupee decline since the beginning of the year, the value has somewhat stabilized. If it starts another huge decline, you should probably start worrying. Until then, probably wait and see.

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