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Indian tech sector takes a thrashing from three directions

'Hire American' order, rising rupee, cloud computing all seen denting earnings

IBM staff leave a company office in Bangalore's Manyata Tech Park. (Photo by 101Reporters.com)

SINGAPORE -- Gathering headwinds are testing the mettle of India's technology sector.

The country's software industry has flourished, unencumbered by the creaky infrastructure that has hindered the growth of manufacturing. But now it faces a triple threat: U.S. President Donald Trump's "hire American" order, the appreciation of the Indian rupee and increasing use of cloud computing.

While the barometer S&P BSE Sensex stock index BSE hit a record high in April, the share price of Infosys -- a leading Indian information technology services company -- has fallen some 10% since the start of this year. Investors are well-aware that conditions in the IT business have taken a turn for the worse.

The stakes are highest, perhaps, in Bangalore. The city in the southern state of Karnataka is known as India's Silicon Valley, home to a host of IT companies. It rose to prominence on the back of an inexpensive yet skilled workforce, with high levels of English fluency and mathematical prowess.

Infosys and other IT players headquartered in Bangalore have seen their earnings soar thanks to such workers, along with tax breaks from the government and a convenient time difference with the U.S. India is 12 hours and 30 minutes ahead of the original Silicon Valley in California -- making it easy for service providers to cover the entire day.

The Trump administration, however, is creating new complications.

Labor dilemma

Trump's "buy American, hire American" executive order toughens screening of applications for H-1B visas, which allow companies to bring skilled foreign workers to fill jobs in the U.S. Ashwin Mehta, an IT analyst at the Nomura group, said in a report last Tuesday that the new order warrants attention because it will adversely affect the Indian IT services industry.

Indian companies like Infosys, Tata Consultancy Services and Wipro are among the top applicants for the H-1B visa program, since they send numerous engineers to the U.S. Indian engineers working stateside are reportedly paid far less than their American-born counterparts. If the government raises the minimum wage for H-1B visa holders or caps the number of workers who can be hired under the program, Indian companies' labor expenses will skyrocket, analysts warn.

Pressure to limit working visas is increasing in other countries, too, such as Australia and New Zealand. Infosys said growing restrictions on the movement of people will push up costs.

Global protectionism will lower Ebitda -- earnings before interest, taxes, depreciation and amortization -- at Indian IT services companies by 0.2% to 0.8% in the coming two to three years, cautioned Abhishek Dangra, a director at credit ratings agency S&P Global.

Higher rupee, lower prices

The rupee's rise is also squeezing earnings at IT companies that rely on the U.S. and Europe for most of their income. With the Indian economy on a comeback trajectory, the nation's currency has been hovering around a 20-month high against the dollar. 

The ratio of operating profit to sales at Tata Consultancy, for example, reportedly dropped by 0.4 of a percentage point in the January-March period, due to the rupee's appreciation.

Meanwhile, the Reserve Bank of India on April 6 raised the reverse repurchase rate, or repo rate, at which it recovers funds from banks. The financial markets took the move as an effective tightening of credit amid rising inflation.

Some analysts expect the Indian central bank will raise its policy interest rate by the end of this year -- fueling speculation that the rupee will head even higher. 

A third headwind is the spread of cloud computing -- the use of remote servers to store, manage and process data. This exerts downward pressure on the prices of IT services and obviates the need for outsourced, custom-built systems.  

In response to these political and technological shifts, Indian IT companies are scurrying to devise next-generation business models. Their price-earnings ratios are already high -- about 16 for Infosys and 18 for Tata Consultancy at the end of 2016. They will need convincing strategies to keep their stock prices propped up. 

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