Investor's Eye dated August 09, 2007

Information Technology

Favourable policy changes

Key points

• The recent policy announcements by the government indicate its growing willingness to protect the rupee against any further appreciation. This is a positive move for the information technology (IT) service companies that have primarily an export-centric business model.
• The policy changes not only allay concerns related to further appreciation in the rupee but could also potentially result in earnings upgrades on the back of the possible weakening of the rupee. The positive impact of the same would be more pronounced in case of the mid-cap companies.
• Despite the distinct pick-up in revenues from the banking, financial services and insurance (BFSI) vertical in Q1 (after a lacklustre performance in Q4), the concerns related to a possible slowdown in demand from the BFSI vertical (in the wake of the subprime woes) would be an overhang on the tech stocks. Especially so, given the fact that the subprime crisis has affected large financial institutions from across the world.
• In terms of our top picks, we continue to prefer HCL Technologies (HCLT; given the company's strong results in the past three quarters, aggressive hedging strategy and reasonably attractive valuations) and Satyam Computer Services (Satyam; based on the distinct improvement in the company's operating metrics, its relatively lower exposure to the BFSI vertical and the strong growth momentum in its enterprise business). In the mid-cap space, we prefer 3i Infotech (purely on valuation basis and due to the company's limited exposure to the US geography).

Banking

RBI modifies ECB guidelines

The government has finally decided to curb the external commercial borrowing (ECB) route, which has been one of the main routes through which overseas money has been entering into India. We had expected a similar announcement during the first quarter monetary policy review. The modifications done to moderate the capital inflows through the ECB route are stated below:

• ECBs of more than US$20 million per borrower company per financial year would be allowed only if expenditure (for permissible end-uses) is in foreign currency; funds raised will need to be parked overseas and cannot be remitted into India.
• While ECBs of less than US$20 million can be raised for rupee expenditure as well, this will need prior approval from the Reserve Bank of India (RBI). Funds raised will need to be parked overseas until actual requirement in India.
• All other aspects of the policy such as the limit of US$500 million per company per year under the automatic route, definition of eligible borrower etc remain unchanged.
• The revised guidelines do not apply to borrowers who have already entered into loan agreements and obtained loan registration numbers from the RBI.

The move is aimed at controlling the dollar inflows via the ECB route as companies have been accessing this route purely to play the interest rate arbitrage mainly for domestic working capital purpose. Some of these borrowings are also getting converted into domestic deposits to exploit the arbitrage that exists between overseas borrowing rates and domestic deposit rates .