The US dollar is expected to get stronger⁠ — that's good news for Indian IT services but not for many others

The US dollar is expected to get stronger⁠ — that's good news for Indian IT services but not for many others
IT companies will have the most to gain if the US Federal Reserve raises interest rates earlier than 2023BCCL/BI India
  • The US dollar is expected to get stronger as fears of inflation increase.
  • This has led to nervousness in the Indian market but Indian IT stocks are resilient in the face of uncertainty.
  • Indian IT behemoths like Tech Mahindra and HCL Technologies are among the best performing stocks today.
Indian markets are nervous as the dollar looks ready to gain back its strength, but IT services stocks, which export software services — like Tata Consultancy Services (TCS), HCL Technologies, Wipro, Infosys and Tech Mahindra — are holding strong.

Change in the share price of the top 5 Indian IT services companies:
Company Change in share price
Tech Mahindra2.37%
HCL Technologies1.39%
Source: NSE, Nifty50 — at closing prices on March 15

Tech Mahindra is the best performing stock among its IT peers. One of the reasons is its latest acquisition — Hyderabad-based Perigord. Tech Mahindra has bought up 70% stake to acquire the leading supplier of consultancy and labelling artwork solutions to the global pharmaceutical industry.

But the cumulatively strength of the industry to stay in the green has more to do with the hopes of a stronger dollar. Like India, the US is currently caught in the conundrum of chasing growth and rising prices.

Investors in the US and Europe are on an earning streak, parking their funds in government securities at near-zero interest rates and making even more in emerging markets like India. But these low interest rates are not likely to last forever.

The European Central Bank (ECB) already announced last week that it would start purchasing bonds at a ‘significantly higher pace’ over the next three months in an attempt to get ahead of any potential inflation pressures in the coming months.

The flip side of getting a big stimulus
US President Joe Biden just signed the country’s $1.9 trillion stimulus package into law and is hoping that will help drive growth. But, where there is growth, there is also inflation. In order to counter the inflation, the central bank needs to step in and increase the interest rates.

The US dollar is expected to get stronger⁠ — that's good news for Indian IT services but not for many others
US Consumer Price IndexBI India

If the Federal Reserve increases interest rates, a stronger dollar would be to the benefit of IT services companies that earn mostly in foreign currency. Tata Consultancy Services (TCS), for instance, earns more than half of its revenue in dollars as an exporter of software services.

The odds of an interest rate hike in the US are rising
The US Federal Reserve’s Chair Jerome Powell has been clear that if it comes to choosing between growth and inflation, the goal is to see more people back at work. “Today, we’re still a long way from our goals of maximum employment and inflation averaging 2% over time,” he said during the Wall Street Journal Jobs Summit on March 4.

While the Fed is positive that it won’t need to step in and adjust interest rates before 2023, some feel that may be too optimistic a point of view. “Very low interest rates, which have held down debt service costs, will eventually rise despite the Federal Reserve’s commitment to an extended period of extremely accommodative monetary policy,” said global agency Fitch Ratings.

This is supported by the fact that Fed Funds Futures — where investors can purchase funds in advance at prices they expect to see in the future — are beginning to signal that the US’ central bank could begin increasing rates in 2022.

According to DataTrek co-founder Nicholas Colas, the odds of the Federal Reserve shifting its policy stance next year has gone from 2% to anywhere between 5% to 10%. That doesn’t necessarily mean that inflation is on the move, but the trend is “clearly not our friend.”

“This means inflation is likely to be a risk well into 2022. I suspect it might even be high enough that the Fed will be seriously considering rate hikes by early 2022,” said Cullen Roche, founder of the Orcam Financial Group.

Good news of Indian IT services’ companies
The rate hike in the US may lead to outflow of dollars from India, and make the rupee weaker, which will, in turn make imported commodities like crude oil more expensive and thereby, hurt a whole lot of businesses.

Only for select companies like the software exporters, a stronger dollar will lead to better earnings in rupee terms.

And hence, the odds of a rate hike in the US rise, so will the prospects for companies like TCS, HCL Tech, Infosys, Wipro and Tech Mahindra.

CompanyOperating profit margin sensitivity to 1% change in USD/INR
TCS25-30 bps
Infosys25-30 bps
Wipro25-30 bps
HCL Tech20 bps
Tech Mahindra15-20 bps
Source: Goldman Sachs

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