The rise of Dollar Index and its impact on flows to India and IT stocks

The fortunes of Indian IT stocks have been closely tied with the state of the US economy as well as the exchange rate. A strong US economy means strong volume growth for the Indian IT companies. At the same time, it also indicates strong USD which generally implies a depreciating INR.

Unlike manufacturing, the biggest expense for IT companies is employee expense. For manufacturing companies, raw material prices are to a large extent a function of global prices.

However, for IT companies a significant portion of their expenses are denominated in INR while their revenues are not. As most IT companies derive almost over 60 percent of their revenues from the US, a strong dollar is overall beneficial for IT companies.

However, cross-currency movements of the USD against other major currencies like the GBP and the Euro also has a bearing on IT companies as most of them derive anywhere between 25-40 percent of their revenues from the UK and the EU.

Generally when the dollar index is in an uptrend like it is currently, the Euro and the GBP starts weakening against the USD which has an adverse impact on IT companies’ revenues.

However, despite adverse cross-currency movements a strengthening dollar index is beneficial for the Indian IT companies. Even after adjusting for adverse cross-currency movements, depreciating INR not only adds to IT companies’ top line but it also helps improving operating margins.

The Dollar index has appreciated sharply in the past few months due to further escalation in the US-China trade war. Brexit drama is also adding to the turmoil.

As a result, the INR has depreciated sharply against the USD which is beneficial for the IT sector and the numbers should start reflecting the same from Q2 onwards.