What, me worry?

Leading information technology stocks, which have been the darling of the Indian investing community, have fallen off their pedestals. They currently trade at a 30 per cent plus discount to their peaks. The problem of course is the rupee's rise against the US dollar. Few expect the rupee to shed the 13 per cent that it has gained against the dollar in the current year, and the general view is that it will rise further. A big question mark therefore hangs over not just the valuation but the performance of Indian IT firms in the immediate future and over the medium term. As salaries keep rising and margins get squeezed, the pressures would have been considerable even without unfavourable currency movements. All three together present a formidable challenge, leading to questions being aired about the future.

Yet, the truth is that the industry leaders are in fine fettle and well equipped to meet the challenge of thriving as global companies. They are the ones "" not the entire industry that Nasscom talks about "" who matter in an industry that is consolidating as it matures. But this should not be taken to mean that the firms will be able to repeat the phenomenal growth that they have clocked in the past, or to protect the kind of margins they have got used to enjoying. In the second quarter of the current financial year, the leading IT firms have recovered from the setback they had suffered in the previous quarter, in terms of the (sequential) quarterly growth of both top and bottom line, and this is expected to continue in the short term. But the growth rate will inevitably slow. The firms can be likened to boys passing through their adolescence when they suddenly shoot up; that growth does not last, but the boys go on to become robust youngsters.

The IT leaders can look forward to a bright future because of the steps they have taken and will continue to do in order to grow and change with the times. They are rapidly developing global footprints by setting up development centres all over the world, thus giving up the earlier practice of offshoring to India most of the work. Also, what could not be offshored earlier was sought to be executed at the client's site with engineers sent from India. Today, the trend is to acquire IT firms in the developed world, thus taking on their employees, so as to raise clients' comfort levels by getting some of the increasingly complex work being outsourced performed near-shore. This will raise dollar expenses, which will take the sting out of rupee appreciation, but also raise staff compensation rates towards mature-economy levels.

The firms have two strategies to counter this "" by going up the value chain and reworking contracts. The good news is that dollar contracts are being revised upwards or restated as euro contracts. In the immediate future, software firms across the board are likely to offer lower increases during the next round of pay hikes. As Indian IT firms compete successfully with global incumbents at the higher end of the market, they will increasingly resemble the latter, including on lower margins. Thus software stocks will not reflect the growth potential that infrastructure stocks currently do in India, but that is because they will increasingly become part of a different global league.