Quitting India

Non-residential Indians pulled out deposits in the March quarter

It's not only foreign institutional investors (FIIs) that have been moving money out of India. Non-resident Indians (NRIs) too have been pulling funds out of the country, albeit to a small extent.

The Reserve Bank of India data show that net NRI flows turned negative in March, with net outflows of $180 million during the month. January had seen net outflows of $79 million, while February had net inflows of $146 million.

The first three months of calendar 2004 have, thus, seen a net outflow of $113 million in contrast to a net inflow of $606 million in the first three months of 2003.

With the RBI lowering the rate of interest payable on NRI savings, bank deposits in April this year, NRI outflows would continue and are likely to be strengthened from April.

Moreover, now that the rupee is no longer appreciating, NRI inflows hoping to gain from rupee appreciation too will slow down.

Rotating back into tech stocks

Is it time to reshuffle portfolios and go overweight on information technology (IT) once again? The latest blow to manufacturing companies comes from the recent hike in oil prices. Most commodities continue to rule at substantially higher prices on a year-on-year basis, raising raw material costs for industry.

What's more, much of India Inc's growth in net profit last year was owing to a large reduction in interest cost. A repeat will not be possible with yields now ruling higher. Higher coal and oil prices, besides increasing costs for the steel and cement industries (it'll be a pass-through for power companies), will also add to inflation in the economy, with obvious effect on interest rates.

Moreover, now that the rupee is no longer appreciating, inflationary pressures will also build up through imports. Apart from the cost push, manufacturing companies are also subject to the vagaries of policy decisions by the government, which is the prime reason the S&P CNX 500 has fallen around 14 per cent since the surprise election results.

But in the same period, the CNX IT index has been practically flat (down 0.6 per cent). One obvious reason is that IT stocks will be largely unaffected by the changes in policy by the government. But apart from the 'policy neutral' factor, IT companies also do not have to contend with higher commodity and oil prices.

Not that there isn't cost inflation or any other concern with IT companies, but importantly, the major concerns of the sector have abated. Pressure on billing rates has almost entirely stopped, while the rupee's one-way journey has also turned.

The wage cost inflation issue, according to analysts, has been tackled well by top companies so far. This has been done by aggressively hiring freshers both on and off campuses. Hiring laterals in the middle-management level, though at times necessary, has been under check as it could lead to significant wage inflation.

In the case of freshers, wage increases are much lower, and in line with the average of 10-15 per cent. Besides, companies such as Infosys have instituted variable compensation plans linked to performance, which has also helped lower cost.

Meanwhile, demand continues to be strong and the trend of high volume growth is expected to continue for at least the top players. The backlash against outsourcing from the US, on the face of it, hasn't impacted volume growth.

But some industry observers claim that customers who have just started and the ones who are considering using offshoring as part of their outsourcing strategy have put some orders on hold.

In some other cases, projects have been handed out but at a low scale, with an assurance to ramp up gradually. One view is that once the US elections are out of the way, these projects will be ramped up quickly, which would result in huge growth.

But things may not be as simple as that. In a worst case scenario, the US economy could slow down in the second half of the year, which, if coupled with falling employment numbers, could cause the backlash to continue.

A lot depends on how the US economy fares, as far as the backlash goes. But given the incremental cost savings, the popularity of offshoring is set to increase.

In short, IT will certainly do well if the US economy improves. On the other hand, if the US economy falters, the downside could be protected by increased outsourcing.

This would probably mean IT stocks would continue to outperform the markets going forward. What works in their favour is that valuations are reasonable, and most investors are currently underweight on the tech sector.

Except for Wipro, which trades at a high 25 times estimated FY05 earnings, most of the top-rung IT companies trade at reasonable valuations. Infy trades at a forward PE of 21.5 times, lower than the estimated earnings growth of 28 per cent in FY05. Satyam Computers and HCL Tech have much lower valuations of 14 times and 16 times estimated FY05 earnings.

With contributions from Mobis Philipose