Anand Kalyanaraman
Any sharp movement in the rupee's exchange rate has inevitably stirred up a hornet's nest in the stock market and corporate circles. Instances which come to mind include the sharp appreciation of the Indian rupee (INR) vis-à-vis the US dollar (USD) during fiscals 2006-07 and 2007-08, when the INR reached its high point since 2000 (around Rs 39 a dollar).
This spike saw India's export-oriented sectors (especially the media-savvy software sector) cry hoarse over dilution of export competitiveness and make high-decibel appeals for government intervention. When the tide turned in fiscal 2008- 09 and the INR began depreciating sharply against the USD and touched its nadir at around Rs 52 to a dollar, import-oriented sectors were perceived to be in trouble.
But are the fortunes of export- and import-oriented companies inexorably linked to movement in foreign exchange rates? Should investors attach much importance to forex movements for companies dependent on foreign trade? We tried to find out, using a limited but representative sample set. The results threw up quite a few surprises.
Counter-intuitive
Ceteris paribus (all other things being equal), export-oriented firms should have taken a hit, seeing their sales, net profit and market cap decline in 2007 and 2008 when the rupee was strengthening, while they should have gained in 2009 when the rupee weakened.
Conversely, import-oriented firms should have been at the wrong end of the stick in 2009, but should have done well in 2007 and 2008. The findings did not conclusively prove either of these trends.
This is particularly so in the case of the poster boy of export-oriented sectors — software. The BSE IT Index (based on market capitalisation of major Indian software companies) rose almost 22 per cent year-on-year in fiscal 2007, at a time when the INR strengthened nearly 3 per cent against the USD. Financial metrics (net sales and net profit) of this group also grew strongly in 2007, again contrary to expectation.
However, in 2008, movement in both market capitalisation (down around 28 per cent) and financial metrics (slower growth) was in line with what was expected from the movement of the rupee (up a sharp 8 per cent). For instance, Wipro's 2008 sales and profit growth was lower than in 2007, and its market cap declined almost 22 per cent in 2008, as against 1.2 per cent growth in 2007. This seemed to suggest that a sustained, sharp movement in the rupee (as seen in 2008) does make the needle move.
However, this relationship broke down in 2009, when despite an almost 26 per cent weakening of the rupee, market capitalisation of the BSE IT Index instead of increasing dipped 36 per cent, and financial metrics also grew only tepidly. Continuing with Wipro's example, its market cap declined almost 43 per cent in 2009, sales growth was lower than in 2008 and profits declined 3 per cent.
An examination of market capitalisation and financial metric movements in companies in other export-oriented sectors (garments and textiles, and diamonds, gems and jewellery) also shows similar results. Company performance did not unduly depend on how exchange rates moved.
For example, garments exporter, Gokaldas Exports, while registering tepid single-digit growth in sales and forex revenue earnings in 2009 saw profits and market cap fall sharply (around 93 per cent and 58 per cent respectively).
Companies in import-oriented sectors such as IT hardware and peripherals, and fertilisers, did in fact exhibit a greater sensitivity to exchange rate movements than export-oriented companies. In an appreciating rupee regime, there were more cases of import-oriented firms showing decline in foreign exchange spend and increase in profits and market-capitalisation.
Similarly, a depreciating rupee saw more cases of importers incur higher foreign exchange expense, while their profits and market capitalisation decreased. For example, computer-peripherals maker Redington India saw its profit growth and market cap decline in 2009.
However, despite having a better score than export-oriented firms, importers also don't always display the expected behaviour in case of sharp exchange rate movements. Fertiliser maker, GSFC, for instance, saw its profits and market cap decline despite an appreciating rupee regime in 2008.
Bigger forces at play
The above suggests the presence of many other factors that impact their numbers, through forces bigger and stronger than forex movements and that the ceteris paribus assumption may be misplaced. Exchange rate is but one among several variables influencing movements of stock prices and profits for companies with a forex exposure.
Other key variables include the state of the global economy, demand and supply dynamics and elasticities, and the ever-fickle market sentiment. All these factors have the potential to overwhelm theoretically linear dynamics between exchange rates, and financial metrics and market capitalisation.
For instance, during the buoyant days prior to the recession when the global economy was growing at a reasonable clip, an appreciating rupee could not make a major dent on the prospects of export-oriented firms as a whole. Likewise, with the onset and steady deepening of the recession in 2009, strong depreciation of the rupee could also not cushion exporters from the negative impact of demand destruction and credit freeze in the developed economies.
Also, presence of hedges against forex movements, whether through forward/futures contracts, or through natural hedges in the form of forex expenses for exporters, and forex incomes for importers, could distort linear relationship, if any.
For example, forex expenses of software firms in the CNX 500 universe are around 40 per cent of their forex revenues. On the other hand, forex incomes of IT hardware firms account for around 40 per cent of their forex expenses.
Factor in forex rates?
Foreign exchange movements have proven notoriously difficult to predict, given their multiple dependencies (interest rates, inflation rates, fund flows, etc). This could make it difficult for investors to take a view on exchange rate movements. This, coupled with the counter-intuitiveness exhibited by firms in several cases, suggests that investors may be better off focussing on other fundamental parameters affecting business prospects, and attach lesser importance to possible impact of forex movements.
Déjà-vu
Seen in the above backdrop, recent instances of exporters expressing concern about the rising rupee (almost 11 per cent up so far in fiscal 2010) evoke a sense of déjà-vu. However, it remains to be seen whether these concerns will translate into reality, given that the global economy is showing incipient signs of recovery.
The key takeaway from our study is that, empirically, linkage between exchange rate movements and performance of companies engaged in international trade has been found to be tenuous and often contrary to expectations.
Investors should rather focus on the bigger picture than trying to factor in exchange rate movements.
Any sharp movement in the rupee's exchange rate has inevitably stirred up a hornet's nest in the stock market and corporate circles. Instances which come to mind include the sharp appreciation of the Indian rupee (INR) vis-à-vis the US dollar (USD) during fiscals 2006-07 and 2007-08, when the INR reached its high point since 2000 (around Rs 39 a dollar).
This spike saw India's export-oriented sectors (especially the media-savvy software sector) cry hoarse over dilution of export competitiveness and make high-decibel appeals for government intervention. When the tide turned in fiscal 2008- 09 and the INR began depreciating sharply against the USD and touched its nadir at around Rs 52 to a dollar, import-oriented sectors were perceived to be in trouble.
But are the fortunes of export- and import-oriented companies inexorably linked to movement in foreign exchange rates? Should investors attach much importance to forex movements for companies dependent on foreign trade? We tried to find out, using a limited but representative sample set. The results threw up quite a few surprises.
Counter-intuitive
Ceteris paribus (all other things being equal), export-oriented firms should have taken a hit, seeing their sales, net profit and market cap decline in 2007 and 2008 when the rupee was strengthening, while they should have gained in 2009 when the rupee weakened.
Conversely, import-oriented firms should have been at the wrong end of the stick in 2009, but should have done well in 2007 and 2008. The findings did not conclusively prove either of these trends.
This is particularly so in the case of the poster boy of export-oriented sectors — software. The BSE IT Index (based on market capitalisation of major Indian software companies) rose almost 22 per cent year-on-year in fiscal 2007, at a time when the INR strengthened nearly 3 per cent against the USD. Financial metrics (net sales and net profit) of this group also grew strongly in 2007, again contrary to expectation.
However, in 2008, movement in both market capitalisation (down around 28 per cent) and financial metrics (slower growth) was in line with what was expected from the movement of the rupee (up a sharp 8 per cent). For instance, Wipro's 2008 sales and profit growth was lower than in 2007, and its market cap declined almost 22 per cent in 2008, as against 1.2 per cent growth in 2007. This seemed to suggest that a sustained, sharp movement in the rupee (as seen in 2008) does make the needle move.
However, this relationship broke down in 2009, when despite an almost 26 per cent weakening of the rupee, market capitalisation of the BSE IT Index instead of increasing dipped 36 per cent, and financial metrics also grew only tepidly. Continuing with Wipro's example, its market cap declined almost 43 per cent in 2009, sales growth was lower than in 2008 and profits declined 3 per cent.
An examination of market capitalisation and financial metric movements in companies in other export-oriented sectors (garments and textiles, and diamonds, gems and jewellery) also shows similar results. Company performance did not unduly depend on how exchange rates moved.
For example, garments exporter, Gokaldas Exports, while registering tepid single-digit growth in sales and forex revenue earnings in 2009 saw profits and market cap fall sharply (around 93 per cent and 58 per cent respectively).
Companies in import-oriented sectors such as IT hardware and peripherals, and fertilisers, did in fact exhibit a greater sensitivity to exchange rate movements than export-oriented companies. In an appreciating rupee regime, there were more cases of import-oriented firms showing decline in foreign exchange spend and increase in profits and market-capitalisation.
Similarly, a depreciating rupee saw more cases of importers incur higher foreign exchange expense, while their profits and market capitalisation decreased. For example, computer-peripherals maker Redington India saw its profit growth and market cap decline in 2009.
However, despite having a better score than export-oriented firms, importers also don't always display the expected behaviour in case of sharp exchange rate movements. Fertiliser maker, GSFC, for instance, saw its profits and market cap decline despite an appreciating rupee regime in 2008.
Bigger forces at play
The above suggests the presence of many other factors that impact their numbers, through forces bigger and stronger than forex movements and that the ceteris paribus assumption may be misplaced. Exchange rate is but one among several variables influencing movements of stock prices and profits for companies with a forex exposure.
Other key variables include the state of the global economy, demand and supply dynamics and elasticities, and the ever-fickle market sentiment. All these factors have the potential to overwhelm theoretically linear dynamics between exchange rates, and financial metrics and market capitalisation.
For instance, during the buoyant days prior to the recession when the global economy was growing at a reasonable clip, an appreciating rupee could not make a major dent on the prospects of export-oriented firms as a whole. Likewise, with the onset and steady deepening of the recession in 2009, strong depreciation of the rupee could also not cushion exporters from the negative impact of demand destruction and credit freeze in the developed economies.
Also, presence of hedges against forex movements, whether through forward/futures contracts, or through natural hedges in the form of forex expenses for exporters, and forex incomes for importers, could distort linear relationship, if any.
For example, forex expenses of software firms in the CNX 500 universe are around 40 per cent of their forex revenues. On the other hand, forex incomes of IT hardware firms account for around 40 per cent of their forex expenses.
Factor in forex rates?
Foreign exchange movements have proven notoriously difficult to predict, given their multiple dependencies (interest rates, inflation rates, fund flows, etc). This could make it difficult for investors to take a view on exchange rate movements. This, coupled with the counter-intuitiveness exhibited by firms in several cases, suggests that investors may be better off focussing on other fundamental parameters affecting business prospects, and attach lesser importance to possible impact of forex movements.
Déjà-vu
Seen in the above backdrop, recent instances of exporters expressing concern about the rising rupee (almost 11 per cent up so far in fiscal 2010) evoke a sense of déjà-vu. However, it remains to be seen whether these concerns will translate into reality, given that the global economy is showing incipient signs of recovery.
The key takeaway from our study is that, empirically, linkage between exchange rate movements and performance of companies engaged in international trade has been found to be tenuous and often contrary to expectations.
Investors should rather focus on the bigger picture than trying to factor in exchange rate movements.
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