The economic news coming out of India these days is the worst in 20 years: a weakening rupee, deepening budget deficits, rising inflation and the prospect of higher interest rates. But that daunting list isn’t all bad news for buyers of Indian outsourcing services, so long as they make the effort to assess the risk exposure of individual providers.
“A weakening rupee can help a buyer if it makes it cheaper to buy services in India,” says R “Ray” Wang, a principal analyst at Constellation Research. “As the rupee gets weaker the dollar is stronger, and those services become cheaper.”
Many buyers have contracts priced in U.S. dollars. This protects them from fluctuations. However, in the present circumstances the trends favor the providers, given that their domestic costs are lower. This is true in the short to medium term, but there is a longer-term risk to buyers who are exclusively dependent on Indian providers who have not diversified their delivery model.
“If there is true inflation in the Indian market, then labor rates are going to go up in India,” says Wang. “If the response is to devalue the currency, we are then dealing as much with psychology and perception.”
Importance of Global Delivery
And if the perception is of economic uncertainty, buyers will do one of two things: They will build in SLAs with Indian providers that have global delivery centers in order to shift risk, or they will consider onshoring to save themselves the headaches.
“A global provider will have a presence in India, China, and Latin America,” says Wang. “They can shift how and when they hire.”
This flexibility, though powerful, can make it harder for buyers to engage in longer-term and higher-value outsourcing relationships. In fact, such flexibility can present a conundrum, given that providers are eager to transition away from low-cost, commodity-based models toward those that include higher touch relationships with their clients.
When the Macro Gets Micro
The macro-economic challenges facing India can seem academic to the distant observer, but they have real effects on the ground that have an impact around the world.
“Inflation has of course been bad for the economy, and the blame is being laid squarely at the current government’s feet,” says Rob Jenkins, a professor of political science at Hunter College, City University of New York. “They got a gift when the US Fed declined to raise rates too.”
With the United States also in crisis-management mode, India has been given some breathing space, because the U.S. dollar has been hobbled by political gridlock and a sluggish economy. However, the U.S. is primed to break out, and if the dollar strengthens India suddenly gets thrown into a “cheap money” relationship with the world’s biggest economy.
This puts the recently-appointed Governor of the Reserve Bank of India, Raghuram Govinda Rajan, in a tough spot. He has limited political independence, which means a weaker rupee and higher rates are a near certainty. Rajan has already proven himself to be a “hawk” by hiking rates.
Omkar Goswami, a director of outsourcing giant Infosys, has raised the warning flag, saying that upping rates would “choke off any hope” and that it would be “the last thing you would want.” The reasons are clear enough: Higher rates both strengthen the currency and shut down growth, a tough sell for an outsourcer.
Then why raise rates? Because a cheap rupee weakens confidence, and investors start cashing in and moving their money to safer havens. In this scenario, an Asian giant become a pauper, with net currency outflows. To address this, India’s leaders can choose to switch some of the country’s reserves to U.S.-denominated bonds or borrow money from the International Monetary Fund, but they can’t simply ignore the problem.
“The current finance minister is an ardent liberalizer,” says Sanjay Ruparelia, a professor of political science at the New School in New York City. “He has pushed reforms favorable to the corporate sector, and is looking for momentum. The head of the Reserve Bank is also highly respected, but it is hard to predict the volatility of the rupee.”
The Nearshore Hedge
In other words, a sudden depreciation could create an economic crisis – one that might have a bigger effect on foreign buyers than on the domestic market, because the first priority of Indian politicians will always be to ensure domestic political and economic stability.
“With a sudden depreciation, you will see a scramble to move more outsourcing out of India and to nearshore environments,” says Wang from Constellation Research. “I expect to see more buyers going to a nearshore solution as a currency hedge.”
The good news is that a hedge can be provided by the Indian outsourcers themselves, with some big providers like Tata Consultancy Services already having significant operations in places like Mexico, where they can serve the U.S. market without having to worry about such uncertainty. This is key for scenarios in which BPO is moving into higher value relationships.
“In this circumstance, a blended option of offshore and nearshore will serve a buyer well,” says Wang. “Sadly, the individual who may be penalized the most is the worker in India.”
There are reports that the surge in support calls sure to be generated by adoption of the Affordable Care Act in the United States will be a mini boom for BPO providers in India, but longer-term concerns still remain. The country is facing general elections in 2014, and it is uncertain what the outcome will be – though fears with regard to a major shift in focus are perhaps overplayed.
“We could see the Congress Party back in power, the Hindu nationalist BJP or a coalition of regional parties,” says Professor Ruparelia. “The last option is the ’Third Front’, which is a coalition of regional parties with a heavy socialist and communist influence. But it is important to note that with all these outcomes, there has been a pattern of liberalization since the 1990s, and that is expected to continue.”
For buyers, no matter what the political and economic future may hold, India will remain a powerhouse. The human and technological depth is too great to ignore. For those buyers looking for a pure play based exclusively on labor arbitrage and economies of scale, the good news surrounding a weakening rupee may sour as rates rise and the value proposition becomes harder to asses. For this reason, the smart money appears to be on India’s larger, diversified players who have truly global capabilities.
Timothy Wilson is a Canadian journalist based in Guadalajara, Mexico. He covers business and technology, as well as cultural and political news. Aside from Global Delivery Report, he freelances for the Canadian Broadcasting Corporation and the Globe & Mail, among other outlets. His blog, “La politica es la politica” covers breaking stories from Mexico and Central America. Follow Tim on Twitter @TimothyEWilson.