One fine morning, I received a call from a close friend. He conveyed me in a jubilant voice that his long cherished dream of going offshore has come true; he was flying within a month. I congratulated and parted off.
Later, I pondered over the reason he had cited for his desperation for an offshore. He had tagged it as 'a necessity.' He had argued that it is much more sensible to pay an EMI of 15k for an owned house, rather than paying 8k as rent for a used, old, ragged shelter he had called as 'room'. The offshore stint shall endow him with a decent down payment corpus, say circa 6lk from a 6 months stay. Some money he had accrued self. The rest, the banks are eager to lend on EMIs. Perfectly logical. I had supported him generously.
However, the only point that made me skeptical about my own assertion was the implicit premise my friend had assumed. I had assumed the same premise. The Indian IT industry, incidentally, has also assumed it, taking it to be as 'granted' perpetually.
The premise is, but, a naive one: The Rupee shall be as weak.
Permit me to be tad technical. The value of INR is pretty low as compared to the USD. The exchange rate of One USD is circa 45 INR. In layman's terms, 1 INR = 2 cents of USD. In Hindi, we can safely call it, "Do Paise Bhar Ki Kiimaat Hai" absolutely, in literal sense!
Infosys began in 1988. Till 1998, only a handful of Indians knew its existence. Most of them were stock brokers and the shareholders. The petit bourgeois, which nowadays finds it as a prestige to tell that their son or daughter is in Infee, a similar cliché that was in vogue for the Sarkari Naukari a decade back, didn't know its existence, per se. Infy is just an illustration. The same story holds true for all Indian IT companies. One more trivia: Patni Computer Services and Oracle Corporation both began on same month of same year.
The point is, why (Indian) IT companies are looked upon as the most coveted place in the eyes of greenhorns (save IITians) vis-a-vis the good old manufacturing sector industries? The one word answers is: Hype.
1991, India did away with the Socialist ideology, which had given them MiG fighter planes whose uncertainty of remaining air-bourne is higher than that of an Indian bride wearing same Saree on her wedding day. Markets were opened. Capitalism was accepted. Privatisation was in-thing. In short, LPG was allowed and so was growth. As a consequence, Rupee fell, miserably. Exports, processed goods and ilk, were pathetic both in quantity and quality. Imports were high. Foreign Investors were scared to invest in, because of outdated laws and policies with things like HDD and IKG being the PM of the country. Foreigners were more happy selling the goods, not investing their money. Prior to LPG, around 1988, One USD was equal to 15 INR. Rupee slid to around 35 for One USD by 1998.
Now, who is benifitted from such situations? One: The developed economies, who have strong currency, Two: The exporters in developing economy, for they get takers for their goods, not necessarily for its quality but, for the sheer reason of the goods being cheap. Why did government allow this? To ramp up its forex reserves, as a backup in case the '1991 Chandra Shekhar do' is repeated.
If one gets a piece of work done for 2 cents, in lieu of One dollar, which businessman would say no; to a profit margin of 98%? Let me reiterate: 'It's not the quality of the Indian Software Programmers (read coders) that attracts US IT MNCs but, the aforementioned margin.'
3000 USD per month. 18000 USD in 6months. 30% living expense. 12,600 USD safely in pocket. Back home: 5,567,000 INR. 3000 USD per month, PPP adjusted, is equivalent to 27,000 INR. 30% living expense. At the end of six months, my friend has only 1,08,000 INR. Just 19% or 1/5th of offshore savings! My friend's logic is perfect. That Indian IT companies is hence a ultimate destination is, however, a perfect hogwash.
FDI inflow in India is unprecedented. Nations and their companies are flocking to invest money in India. Reason? Huge potential Consumer Market. The incomes have soared, thanks to rupee devaluation. Banks are eager to lend: Personal, House or Corporate loan. The consumer has become aware of the term called 'Quality of Life' and has no qualms in buying commodities (read comforts) on credit. Cause? One: The purchasing power, i.e., incomes, have shot up. Two: Credit is available; aplenty and hassle free.
Now, when stronger currency is ready to buy a weaker one (the FDI inflow), the value of the weaker currency improves. FDI, by definition, is in infrastructure viz. roads, power, et al. Never services. The latter may get collateral benefits, nonetheless.
The issue is this: If Rupee appreciates - which it has already started to, as the regulator is doing away with the artificial ways to keep it weak (to support exports, in order to counter imports) - the foreign importer will loose the cost advantage they derive from India! Say, tomorrow One USD can just buy 15 INR, that translates that for a foreign importer, the product shall be dearer by 3 times, or only a third of the quantity of the product can be bought with same amount of foreign currency! Additionally, IT companies gets tax sops from the government, which helps them improve their margins, artificially. For record, the profit margin margin of the most respected Indian IT company for fiscal year 2005-06 was mere 23%, after sops. Without sops in place, it would have hovered circa 20%, equivalent to a 130 years FMCG company in the country. FMCG companies have pretty low profit margin, ascribing because of the altogether different business model they run on. Now, a 20% margin is pretty tight. Services Sector (unfortunately) contributes to over 50% of the GDP of the country. Agriculture 21%. Manufacturing, less than 15%. Funny thing is, the profit of the top rung manufacturing industry (run by the government) is at least 100 times the total revenue of the most respected Indian IT company! However, the greenhorns find it more enticing to join the latter. Reason: Higher package. Can one tell me, now, which company can give you higher package; the one with 1 rupee as revenue or a company with 100 rupees as profit? OK. You bothered about the rise? The one with linear gradient versus the one with exponential one? Very well. Doesn't the exponential function gets asymptotic for higher values of x? Apart from that, the amount of rise is a function of profit margin. Lower the margin, lesser is the rise and so are the chances.
Only a fraction of business of Indian IT companies comes from local customers (>91% offshore). And mind you, no one, not even a roadside cobbler, runs business on philanthropic or altruistic objectives. They look good only in the HR newsletter. For the rest, the truth is always the bottomline. If it plummets, well, you can now guess what it will do.
_______________________
Add on (February 24)
Yesterday, one more MiG crashed. :D
_______________________
Add on (March 1)
In the forthcoming financial year, the IT companies have to pay 11.3% Minimum Alternate Tax (MAT) that will plummet their bottomline upto 2%. The sops are, hence, being reduced. By 2009-10 fiscal, they will be removed completely. I wonder there will be any IT company running post that. :)
_______________________
Add on (May 08)
One more MiG crashed today. :D
________________________
Add on (June 19)
http://www.rediff.com/money/2007/jun/11dollar.htm
Later, I pondered over the reason he had cited for his desperation for an offshore. He had tagged it as 'a necessity.' He had argued that it is much more sensible to pay an EMI of 15k for an owned house, rather than paying 8k as rent for a used, old, ragged shelter he had called as 'room'. The offshore stint shall endow him with a decent down payment corpus, say circa 6lk from a 6 months stay. Some money he had accrued self. The rest, the banks are eager to lend on EMIs. Perfectly logical. I had supported him generously.
However, the only point that made me skeptical about my own assertion was the implicit premise my friend had assumed. I had assumed the same premise. The Indian IT industry, incidentally, has also assumed it, taking it to be as 'granted' perpetually.
The premise is, but, a naive one: The Rupee shall be as weak.
Permit me to be tad technical. The value of INR is pretty low as compared to the USD. The exchange rate of One USD is circa 45 INR. In layman's terms, 1 INR = 2 cents of USD. In Hindi, we can safely call it, "Do Paise Bhar Ki Kiimaat Hai" absolutely, in literal sense!
Infosys began in 1988. Till 1998, only a handful of Indians knew its existence. Most of them were stock brokers and the shareholders. The petit bourgeois, which nowadays finds it as a prestige to tell that their son or daughter is in Infee, a similar cliché that was in vogue for the Sarkari Naukari a decade back, didn't know its existence, per se. Infy is just an illustration. The same story holds true for all Indian IT companies. One more trivia: Patni Computer Services and Oracle Corporation both began on same month of same year.
The point is, why (Indian) IT companies are looked upon as the most coveted place in the eyes of greenhorns (save IITians) vis-a-vis the good old manufacturing sector industries? The one word answers is: Hype.
1991, India did away with the Socialist ideology, which had given them MiG fighter planes whose uncertainty of remaining air-bourne is higher than that of an Indian bride wearing same Saree on her wedding day. Markets were opened. Capitalism was accepted. Privatisation was in-thing. In short, LPG was allowed and so was growth. As a consequence, Rupee fell, miserably. Exports, processed goods and ilk, were pathetic both in quantity and quality. Imports were high. Foreign Investors were scared to invest in, because of outdated laws and policies with things like HDD and IKG being the PM of the country. Foreigners were more happy selling the goods, not investing their money. Prior to LPG, around 1988, One USD was equal to 15 INR. Rupee slid to around 35 for One USD by 1998.
Now, who is benifitted from such situations? One: The developed economies, who have strong currency, Two: The exporters in developing economy, for they get takers for their goods, not necessarily for its quality but, for the sheer reason of the goods being cheap. Why did government allow this? To ramp up its forex reserves, as a backup in case the '1991 Chandra Shekhar do' is repeated.
If one gets a piece of work done for 2 cents, in lieu of One dollar, which businessman would say no; to a profit margin of 98%? Let me reiterate: 'It's not the quality of the Indian Software Programmers (read coders) that attracts US IT MNCs but, the aforementioned margin.'
3000 USD per month. 18000 USD in 6months. 30% living expense. 12,600 USD safely in pocket. Back home: 5,567,000 INR. 3000 USD per month, PPP adjusted, is equivalent to 27,000 INR. 30% living expense. At the end of six months, my friend has only 1,08,000 INR. Just 19% or 1/5th of offshore savings! My friend's logic is perfect. That Indian IT companies is hence a ultimate destination is, however, a perfect hogwash.
FDI inflow in India is unprecedented. Nations and their companies are flocking to invest money in India. Reason? Huge potential Consumer Market. The incomes have soared, thanks to rupee devaluation. Banks are eager to lend: Personal, House or Corporate loan. The consumer has become aware of the term called 'Quality of Life' and has no qualms in buying commodities (read comforts) on credit. Cause? One: The purchasing power, i.e., incomes, have shot up. Two: Credit is available; aplenty and hassle free.
Now, when stronger currency is ready to buy a weaker one (the FDI inflow), the value of the weaker currency improves. FDI, by definition, is in infrastructure viz. roads, power, et al. Never services. The latter may get collateral benefits, nonetheless.
The issue is this: If Rupee appreciates - which it has already started to, as the regulator is doing away with the artificial ways to keep it weak (to support exports, in order to counter imports) - the foreign importer will loose the cost advantage they derive from India! Say, tomorrow One USD can just buy 15 INR, that translates that for a foreign importer, the product shall be dearer by 3 times, or only a third of the quantity of the product can be bought with same amount of foreign currency! Additionally, IT companies gets tax sops from the government, which helps them improve their margins, artificially. For record, the profit margin margin of the most respected Indian IT company for fiscal year 2005-06 was mere 23%, after sops. Without sops in place, it would have hovered circa 20%, equivalent to a 130 years FMCG company in the country. FMCG companies have pretty low profit margin, ascribing because of the altogether different business model they run on. Now, a 20% margin is pretty tight. Services Sector (unfortunately) contributes to over 50% of the GDP of the country. Agriculture 21%. Manufacturing, less than 15%. Funny thing is, the profit of the top rung manufacturing industry (run by the government) is at least 100 times the total revenue of the most respected Indian IT company! However, the greenhorns find it more enticing to join the latter. Reason: Higher package. Can one tell me, now, which company can give you higher package; the one with 1 rupee as revenue or a company with 100 rupees as profit? OK. You bothered about the rise? The one with linear gradient versus the one with exponential one? Very well. Doesn't the exponential function gets asymptotic for higher values of x? Apart from that, the amount of rise is a function of profit margin. Lower the margin, lesser is the rise and so are the chances.
Only a fraction of business of Indian IT companies comes from local customers (>91% offshore). And mind you, no one, not even a roadside cobbler, runs business on philanthropic or altruistic objectives. They look good only in the HR newsletter. For the rest, the truth is always the bottomline. If it plummets, well, you can now guess what it will do.
_______________________
Add on (February 24)
Yesterday, one more MiG crashed. :D
_______________________
Add on (March 1)
In the forthcoming financial year, the IT companies have to pay 11.3% Minimum Alternate Tax (MAT) that will plummet their bottomline upto 2%. The sops are, hence, being reduced. By 2009-10 fiscal, they will be removed completely. I wonder there will be any IT company running post that. :)
_______________________
Add on (May 08)
One more MiG crashed today. :D
________________________
Add on (June 19)
http://www.rediff.com/money/2007/jun/11dollar.htm
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