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Is India's software story about to be stopped in its tracks?
That would have been an unthinkable question just two months ago as India's software firms tucked one US$100 million client after another under their belts and turned in ever higher profits.
Suddenly the giant-killers who've pulled out their slingshots and taken on global behemoths like IBM, Accenture and Computer Services Corporation, are looking just a teeny-weeny bit vulnerable.
Nope, they haven't misplaced the magic formula that has conjured up profits for over a decade. They've been clobbered by the muscular rupee which has been moving from strength to strength over the last year.
"Our earnings are in dollars and our expenses in local currency," explains Raman Roy, chief executive of Quattro, who's one of the founding fathers of the Indian business process outsourcing industry.
The jitters began when Infosys, India's second-largest and most high-profile software services firm, unveiled its quarterly results this month.
Infosys is a conservative company which in the last 12 quarters has never disappointed the army of investors and analysts, delivering around 30 per cent growth for the last three or four years, much better than companies like IBM against which it competes.
This time growth came in under expectations. In the following days other software giants like Wipro and the largest of them all, TCS, also announced results that weren't as sparkling as usual and well inside analysts' predictions.
Let's get one thing clear: the results weren't shockingly bad. But these are the best students in class, the ones who never ever come home with less than 95 per cent on their report cards.
The reason for the falling grades isn't hard to figure out. As the software companies earn in dollars, they get less bang for their greenbacks when they are converted into rupees.
You could argue that the Indian economy has, to an extent, almost become a victim of its own success. Foreign exchange reserves stand at an astonishing US$219 billion ($287 billion) and that figure is rising every month as international investors seek a slice of "the India story".
Even foreign direct investment has zoomed to US$17 billion between April 1, 2006 and March 31, 2007 from about US$7 billion one year earlier.
This year foreign institutional investors have put in US$10 billion - about US$5.75 billion this month - thanks a raging raging bull market - that nobody predicted. That's compared to the US$8.8 billion that came in last year.
The result is that it's getting tougher to stop the rise of the rupee, which has climbed by over 15 per cent since last July and by about 9.3 per cent since March. Last week it touched a nine-year high of 40.28 rupees against the dollar. Some analysts predict it will end the year at about 35 rupees to the US dollar. India's Reserve Bank also seems happy about the rising rupee because it's helping neutralise inflation by reducing import prices.
That's great for importers and it will bring down the oil bill - that's a relief considering the way prices are moving. But it's a disaster for exporters and the software services industry which has been a key constituent of this decade's India growth story.
The bigger companies still have huge cushions to fall on to but the smaller companies which don't have 30 per cent margins are already feeling the pain. Says Roy: "There are a lot of people who were on profit margins of 5 per cent and 6 per cent. They will be bleeding now."
The software giants were the locomotives that tugged the stock market along in their fast-moving wake. This year the giants like Infosys and TCS have been slipping even as the market has climbed to new heights and they've ceased to be the darlings of the bourses and the brokers.
"I would look [for buys] at software companies catering to the domestic market more than the large ones that are exporting," says Deepak Lalwani, director, Astaire & Partners, a London-based brokerage house.
What's the way out for India's czars of the call centres and software codes?
Infosys showed one way forward when it closed an outsourcing deal last week that included the takeover of three call centres in Poland, Thailand and India, run by Philips. The deal's not huge but is part of efforts to reduce the huge dependency on the US market and the crumbling dollar.
Right now all the players in the software industry, worth almost $40 billion of which the US accounts for two-thirds, are working round the clock chasing customers in Europe and other corners of the world - with varying degrees of success. But the sheer size of the US market means it will always account for a large chunk of business.
Is this a temporary blip or the first sign that India's high-tech stars are losing steam? Industry analysts point out there's no shortage of customers still lining up to outsource work to India. But if the rupee rises too high, it could reduce margins further and spell trouble. Even Indian companies might start moving work to other locations.
"The question is how does the Philippines price it versus how do we price it, versus how does Sri Lanka price it," says Roy.
How important is the software industry to the India growth story? You could argue that the software services and business process outsourcing industries only employ 1.4 million people - and that's a drop in an ocean of 1.1 billion. But this isn't the full story. The high-tech industries help to kickstart a slew of other industries including catering and taxi services.
If that's not enough the booming software companies are also gobbling up office space like there's no tomorrow. Consider that TCS is moving ahead with plans to hire about 32,000 new staff this year and it's easy to understand why it needs several million square metres of extra space to house the newcomers.
As India's economy starts firing on all cylinders, the software sector is becoming less important, but no other industry can soak up the tens of thousands of graduates who enter the job market every year, and that isn't going to change for a long time.
