November 16, 2004
A weak dollar and the IT industry in India

backgrounder in NYT about the impacts of the falling dollar :


"...There are at least three schools of thought on whether a dollar collapse is likely and, if it happens, what it would mean.

One group, which includes the Federal Reserve chairman, Alan Greenspan, contends that ...the dollar may well decline in value,.. but the decline would be gradual and would help reduce American trade imbalances by making exports cheaper and imports more expensive. The Bush administration goes one step further, arguing that America's huge foreign debt simply reflects the eagerness of others to invest here....(Ed: Dr DeLong demolished the treasury department argument in this post).

A second school of thought holds that foreign governments like China and Japan will continue to finance American borrowing and keep the dollar strong because they are determined to sustain their exports and create jobs.

But a third school, which includes officials at the International Monetary Fund, worries about a collapse in the dollar that would send shock waves through the global economy. ..... That group argues that the dollar needs to depreciate another 20 percent against the other major currencies but warns about a run on the dollar that could reduce its value by 40 percent.

A collapse of that size would severely affect Europe and Asia, which ave relied heavily on exports to the United States for their growth. steep drop in the dollar could lead to higher interest rates for the federal government and American private borrowers, as foreign investors demanded higher returns to compensate for higher risk. And it could expose hidden weaknesses among financial institutions and hedge funds caught unprepared.

"There is a school of thought that the U.S. can keep borrowing forever," said Kenneth S. Rogoff, professor of economics at Harvard University and a former chief economist at the I.M.F. "But if you add up all the excess saving being thrown out by the surplus countries, from China to Germany, the United States is soaking up three-quarters of it right now."...

For Mr. Rogoff and several other economists, the question is not whether the dollar declines - but how fast and how far the fall turns out to be."

What does it mean for India?

Bad things obviously. We are sitting on the biggest reserve of US$ in our history. I read a few news stories that suggested that Chadambaram is looking to invest them in infrastructrue projects. (I wish we would use it to pay off part of our debt!)

The IT Industry is probably slightly better prepared for the short term. The big three have long since recognized that future holds a stronger Rupee. They may be able to buy themselves some protection fo the immediate future, . But in long run, it would obviously impact their revenue stream adversely - about half of India's IT revenues come from USA.

Unfortunately, this is happening at a time when the effects of rising staff cost are also being felt. The bigger firms are increasingly looking towards China and elsewhere to bridge the resource gap. (I should note here that right now English speaking Chinese software engineers are more expensive. But Indian salaries should reach parity soon. On the other hand, the churn rate in China is lower. They also have a larger pool of untapped IT personnel). Add to this, increasing commoditization of many sortware support / maintenance activities.

IT sector in India is staring at serious margin erosion. I think we are looking at a shake up in the industry in the next two to three years. Obviously like all such naval gazing, this could be way off base.

This article in Outlook looked at a different set of parameters and reached similar conclusions.

Posted by Kaushik at November 16, 2004 09:08 PM | TrackBack
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