Software uncertainties

Storm clouds have gathered lately over the Indian information technology sector. The Budget did not help, by bringing software export earnings within the purview of the minimum alternate tax, raising the incidence of the dividend distribution tax and imposing the service tax on rent incomes of landlords (many software firms operate out of rented properties). However, all these measures become effective only in the current financial year, thus not impacting the earnings of the fourth quarter, which will be announced shortly. What will affect the last quarter's earnings is the (small) appreciation in the value of the rupee vis-à-vis the US dollar. Thus, we have the dual scenario of a marginal downturn being possible in the reporting quarter and a tougher scenario in the new year. However, the rupee's appreciation will have negligible impact because, over the quarter, the Indian currency has appreciated by less than 1 per cent. Besides, most software companies have become wiser after burning their fingers over exchange rate changes in the past, and have been hedging their hard currency receivables. To the extent that they have hedged their incomes, and since their costs are known and accounted for, firms can be expected to mostly meet their earnings forecasts. It is those that have left uncovered positions who are likely to take a small hit. Here too, it needs to be emphasised that about 40 per cent of the earnings of software firms is spent on meeting the expenses of staff stationed offshore and paid in dollars. So the net impact of exchange rate appreciation will be felt only on the portion of earnings spent in meeting offshore expenses.

The outlook for the new year is more uncertain. Other than the impact of budgetary measures, there is continuing uncertainty about rupee appreciation""though it is to be expected that the software firms will go in for extensive hedging (which, let it be remembered, is not without cost). It is also necessary to remember that the Indian software industry has been going through a consolidation phase. As the technology analysis firm Forrester has pointed out, in a short space of three years (2004-07) the share of the top three software companies in total software exports is set to go up from 26 per cent to 41 per cent. Not only are these giants far more robust than the rest of the industry, they mostly operate out of their own premises (so there will be little or no impact of the service tax on rent incomes of landlords) and usually manage to stay a step ahead of industry""impacting developments. What is likely is that the new year will begin with more modest forecasts, but that is not to say that is how the year will end. The experience so far has been that even when earnings guidance is modest in a new year, by the time the year is out, revised guidance turns out to be a different story. In one particular aspect the industry leaders see no danger ahead at all""the prospects of a US economic slowdown. The expectation is that if the going gets tough for US corporations, they will seek to cut costs more and end up "offshoring" even more than before. Besides, the top Indian vendors have been rapidly expanding their offerings and moving up the value chain. So, while they do see minor hurdles ahead, their overall outlook remains buoyant.