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PP RUEHCHI RUEHDT RUEHHM RUEHNH RUEHPW
DE RUEHBI #0046/01 0421112
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P R 111112Z FEB 08
FM AMCONSUL MUMBAI
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RUCPDOC/DEPT OF COMMERCE WASHINGTON DC

UNCLAS SECTION 01 OF 05 MUMBAI 000046 
 
SIPDIS 
 
SIPDIS 
 
DEPT PASS TO COMMERCE FOR ART STERN 
 
E.O. 12958: N/A 
TAGS: ECON EIND ETRD IN
SUBJECT: INDIAN IT AND TEXTILE INDUSTRIES STRUGGLE TO COPE WITH 
MATURING BUSINESS MODELS AND A RISING RUPEE 
 
MUMBAI 00000046  001.2 OF 005 
 
 
¶1.  (U) This cable is classified as sensitive but unclassified. 
Please treat accordingly. 
¶2.  (U) Summary:  India's two largest foreign exchange earners - 
the textile and IT industries -- are struggling to adjust to the 
appreciation of the Indian rupee against the dollar.  However, 
in a series of discussions with interlocutors from the IT and 
textile industries, Congenoffs learned that the rising rupee is 
just one of many problems faced by the two industries.  The 
software industry's trade association, NASSCOM, said 
expectations of a slowing U. S. economy and a human resource 
crunch resulting from the booming domestic economy are equally 
responsible for the industry's current challenges.  A 
representative from the textile industry also noted that the 
expectation of a slowdown in the U. S., coupled with the 
expiration of the multi-fiber agreement, have also hit the 
industry.  Both industries are trying to cut costs and are 
looking to new export markets for revenue.  While the IT 
industry has been trying to lobby the Government of India to 
preserve tax breaks on exports, the textile industry has been 
trying to obtain similar tax breaks.  Irrespective of whether 
they are successful, both industries feel the imperative to 
develop innovative strategies and re-tool business models to 
stay afloat and weather the current crisis.  End Summary. 
 
IT and Textile Industries Among Biggest Export Earners 
--------------------------------------------- --- 
¶3.  (U) The information technology (IT) and textile industries 
are important export industries and foreign exchange earners for 
the Indian economy.  In 2007, the IT industry's revenues touched 
USD 39.6 billion of which USD 31.4 billion were exports.  At the 
end of 2007, the industry directly employed 1.6 million people 
and accounted for 5.4 percent of India's GDP.  After years of 
fast growth, the IT industry is well-represented with the top 20 
IT companies, who generate 80 percent of export revenues of the 
industry.  The industry is projected to grow 12-15 percent in 
2008 after years of 30 percent plus annual growth.  Estimated to 
employ 2.5 million people, the textile industry is one of 
India's oldest industries.  The textile industry's export 
revenue stood at USD 20 billion and accounted for one-sixth of 
India's total export revenue in 2006 according to DGCIS 
(Directorate General of Commercial Intelligence & Services) 
data.  The textile industry is very fragmented, with almost 300 
exporters earning revenues over USD 25 million. 
 
Twin Impact of Rising Rupee and Slowing U.S. Economy Too Much 
Too Fast 
--------------------------------------------- -------- 
¶4.  (U) Rajiv Vaishnav, Regional Director of the National 
Association of Software & Service Companies (NASSCOM), told 
Congenoffs that the profitability of the Indian IT industry has 
recently taken a double hit: first, by the speed of the rupee 
appreciation via-a-vis the dollar, and second, by the slowdown 
in the U.S. economy.  The Indian IT industry has primarily been 
export driven with the domestic IT industry accounting for only 
around 20 percent of the total industry revenues, Vaishnav 
explained; of these exports, the U.S. market accounts for over 
50 percent.  The slowdown of the U. S. economy has therefore 
dampened future growth prospects for the industry, although he 
admitted that the immediate fallout is lower profit margins, 
rather than decreased growth.  In a separate discussion, Atul 
Nishar, the chairman of Hexaware Technologies, confirmed this 
trend.  He reported that while his company's profit margins had 
been impacted, sales growth largely remained intact despite the 
company's dependence (more than 50 percent of sales) on the U.S. 
market. 
¶5.  (U) In a separate discussion, Rahul Mehta, the President of 
the Clothing Manufacturers Association of India (CMAI), pointed 
out that the speed at which the rupee appreciated (12 percent 
since January 2007, with a rise of almost 10 percent since April 
2007) caught textile exporters off-guard.  If the rise had been 
spread over a longer period of time, he said, then exporters 
could have adjusted the pricing of contracts with their 
suppliers and customers.  He stated that the impact of the 
stronger rupee via-a-vis the dollars was even more severe, as 
70-80 percent of the textile industry's export revenues are 
dollar denominated.  The U.S. accounts for 30-35 percent of the 
 
MUMBAI 00000046  002.2 OF 005 
 
 
industry's export market.  All exports to Middle Eastern markets 
and 70 percent of European sales are also priced in dollars, he 
explained.  Manojj Kumar Patodia of Prime Textiles, a major 
textiles manufacturing firm with mills in Tirupur in Tamil Nadu, 
confirmed that many of his company's European contracts were 
priced in U.S. dollars, and he was looking to switch to Euro 
pricing.  Mehta also pointed out that the industry had an import 
content of just 3-5 percent, and therefore had little scope to 
offset the impact of the stronger rupee.   He admitted that 
India's lowering of import tariffs for imported fabrics to meet 
its WTO commitments would increase the percentage of imported 
fabric content in textile exports. 
¶6.  (U) Moreover, Mehta continued, along with the weakening of 
the dollar, the slowdown in the U.S. economy has resulted in 
fewer orders and reduced margins.  The industry had been able to 
handle this scenario in the past because the multi-fiber 
agreement had ensured that Indian suppliers had access to some 
portion of the U.S. textile market.  But with its expiry, Indian 
manufacturers now have to compete with cheaper Chinese 
manufacturers and Southeast Asian manufacturers, he explained. 
Margins are therefore very slim for textile exports.   He 
claimed that the average margin for a textile exporter is just 
8-9 percent, so a 10-11 percent appreciation in the rupee has 
wiped out margins.  As a result, several exporters are currently 
running their business at a loss and hope to ride out the 
crisis, he continued. 
¶7.  (U) In contrast to CMAI Mehta's claims, Patodia of Prime 
Textiles informed Econoff that, surprisingly, his business had 
started to turn around in the last month.  Whereas he had 
partially retooled his business towards the domestic economy, he 
was also discovering that international buyers did not want to 
be solely reliant on China for their purchases and were willing 
to continue supplier relationships with Indian firms, despite 
their higher pricing, to diversify.  Indian firms are reliable 
suppliers of high quality goods, which Patodia claimed many of 
his other South Asian competitors cannot promise.  Tax sops or 
no tax sops, Patodia, for one, was optimistic about the business 
outlook for the rest of the year. 
 
IT & Textile Industry Both Lobby for Tax Breaks to Soften the 
Rupee Rise 
--------------------------------------------- ----------- 
¶8.  (U)  Vaishnav informed Congenoffs that NASSCOM is lobbying 
the Indian government to preserve tax exemption on export 
earnings for IT industries under the Software Technology Parks 
of India (STPI) scheme.  (Note: The government created the STPI 
scheme to encourage and enhance software exports from India by 
setting up dedicated software technology parks with good 
infrastructure, technology, and professional training services. 
The STPI is aimed at facilitating the software export industry 
and especially the SME (small and medium enterprise) segment to 
maintain a competitive edge in the global market.  End Note.) 
Units in the STPI were given a 10-year tax holiday, which ends 
in March 2009.  NASSCOM wants this extended for another 10 
years.  Congenoff pointed out that the Indian IT sector's pleas 
for continued tax breaks and other government sops to ensure its 
survival contrasted with the projection of its image 
internationally, in which industry representatives routinely 
boasts about its world class products and competitive pricing. 
¶9.  (U)  Vaishnav maintained that these exemptions were critical 
for the SME segment of the Indian IT sector, which he claims is 
most severely affected by the rising rupee.  While the larger IT 
companies have the financial resources and the knowledge to 
hedge against currency appreciation, small and medium IT 
companies do not, Vaishnav said.   He claims that the withdrawal 
of tax sops under STPI will hit the SME segment 
disproportionately hard.   Large IT companies can always move 
their operations to Special Economic Zones (SEZs) and thereby 
preserve these tax breaks.  But smaller companies do not have 
this option because of the high rental cost at the SEZs, 
Vaishnav explained.   NASSCOM has been lobbying the Indian 
central government to preserve these tax breaks for the last two 
years and Vaishnav believes that there is a 60 percent chance of 
success.  Atul Nishar, the Chairman of Hexaware Technologies and 
the former Chairman of NASSCOM, was even more optimistic and 
expects tax relief in the coming budget.  He pointed out that 
 
MUMBAI 00000046  003.2 OF 005 
 
 
the government will be seen as favoring large corporates and 
ignoring the SME sector if it removes tax benefits in STPIs but 
keeps these incentives in SEZs. 
¶10. (U)  CMAI's Mehta separately told us that like the IT 
industry, the SEZ model was not feasible for the textile 
industry which also primarily consists of small- and 
medium-sized players.  The barriers between the domestic and 
export industry are breaking down in the textile sector, he 
noted.  Textile exporters also sell their goods to the domestic 
market and while not prohibited, domestic sale from a company in 
an SEZ is an administrative inconvenience, he added. 
¶11.  (U)  CMAI, like NASSCOM, is also lobbying the government 
for tax concessions.  Mehta told us that the industry is 
demanding that textile exporters get refunds of state and local 
taxes paid in addition to the existing refund of federal tax. 
These account for 4-6 percent of the FOB (freight on board) 
price of the good, he added.  Patodia of Prime Textiles called 
state and local taxes the number one impediment to his business. 
 Mehta of CMAI also said that the industry is lobbying for a 
lowering of domestic interest rates of around 9 percent charged 
to exporters to the internationally prevailing 3-4 percent.  The 
textile industry wants more flexible labor laws which permit 
temporary and contract employment in the textile industry, 
although he privately acknowledged that this is a tall order 
given the current political alignment in Delhi.  Mehta added the 
industry was demanding cheaper and more reliable electricity 
supply. 
 
Slowing U.S. Economy Forces Export Diversification 
--------------------------------------------- ----- 
¶12. (U) Vaishnav stated that the IT industry is now looking to 
diversify its export revenue base to Europe and Asia -- two 
relatively untapped markets -- to cope with the twin impact of a 
rising rupee and slowing U.S. economy.  Vaishnav noted that the 
IT company Datamatics, for example, now obtains most its export 
revenue from the U.K.  Nishar of Hexaware added that his company 
is planning to reduce its exposure to the U.S. market from the 
current level of 68 percent to less than 60 percent.  Nishar 
also believes that while the Indian IT industry will be badly 
hit in 2007-08, he expected that a revival of the U.S. economy 
in 2009 will lead more U.S. companies offshore to India as they 
become even more aware of cost efficiencies.  The Indian IT 
industry will therefore see an uptrend in business in 2009-10, 
he opined.  He sees the current business environment as similar 
to 2001-2002 when a slowdown in the U.S. initially hit the 
Indian IT industry hard but was followed by a sudden upswing in 
business as U.S. firms decided to increase off-shoring to 
contain costs and build shareholder value. 
¶13.  (U) Meanwhile, CMAI's Mehta stated that Indian textile 
manufacturers were also looking to diversify into new markets. 
He himself led a trade delegation under CMAI to Chile and will 
soon take a delegation to China, which Mehta claimed was open to 
receiving exports from India because China's industry so dwarfed 
India's that it did not feel threatened.   Mehta admitted that 
the industry had been short-sighted, developing trade relations 
with the U.S., Europe and Middle Eastern countries at the 
expense of Latin American, Southeast Asian, Eastern European and 
East Asian nations.   The industry is now looking at these 
markets as export destinations and not just as sources of 
supply. 
 
Cost-cutting Measures to Stem the Impact 
------------------------------------ 
¶14.  (U)  NASSCOM's Vaishnav also told us that the IT industry 
is trimming costs to improve eroding bottomlines.  The industry 
is trying to lower the salary expectations of its employees and 
is also cutting down on the "extra" benefits or frills given to 
employees.  Analysts believe that the IT industry wage bill will 
appreciate by only 10-12 percent this year, as compared to an 18 
percent rise in wages last year.  Tata Consultancy Services, one 
of the largest Indian software exporters, shaved off around two 
percent of the variable pay linked to the company's performance 
from its employees' salary for the January-March quarter. 
Equity analysts believe this cut is designed to send a message 
to employees that all is not well with the IT sector, so as to 
lower their annual salary review expectations.   Along with 
 
MUMBAI 00000046  004.2 OF 005 
 
 
managing wage costs, the industry is looking to expand to 
lower-cost Tier 2 and Tier 3 cities (smaller towns and cities); 
Vaishnav described this as the motivation behind the recent 
establishment of a new office of Datamatics Corporation in 
Nashik, Maharashtra, and the plans for Satyam to open an office 
in Nagpur.  Hexware's Nishar confirmed these cost-cutting 
measures and said his company was not only lowering salary 
expectations but is also increasing the work day of its 
employees from 8 to approximately 9 hours a day.  Nishar will 
also try to increase the percentage of employees being utilized 
at a given time, from the current 70-75 percent.  Nishar added 
that his company, along with several other larger IT players, 
planned to increase billing rates both for renewals and new 
contracts to soften the impact of the strengthening rupee. 
¶15. (U) CMAI's Mehta, told us that while large Indian textile 
exporters have cut staff to trim costs, some small manufacturers 
have simply been forced to shut down.  He estimated that as of 
November 2007, the industry had lost 75,000 jobs, and he expects 
150,000 job losses by March 2008. (Note: Mehta confidentially 
admitted that many of these "laid-off" workers were absorbed 
into the booming domestic textile industry or went back to the 
villages to resume agriculture.  End Note). 
 
IT Human Resource Crunch Unlikely Fallout of the Booming Indian 
Economy 
--------------------------------------------- ----- 
¶16. (U) Vaishnav noted that the booming domestic economy has 
shrunk the large pool of professionals from other industries who 
wanted to move into the IT sector.  For example, Vaishnav 
pointed out that whereas ten years ago, civil engineers were 
ready to enter the IT sector, few do so today because of the 
vast job prospects available in developing India's 
infrastructure.  NASSCOM projects that India's emergence as a 
preferred outsourcing destination has created the need for over 
2 million professionals by 2010.  It estimates a shortage of 
500,000 skilled workers if remedial action is not taken. 
¶17. (U) To address the potential human resource crunch, NASSCOM 
itself is establishing twenty new IIITs (Indian Institutes of 
Information Technology) to create highly specialized 
professionals with skill sets in emerging technologies that are 
not yet mainstream.   The first five new IIITs, which will be 
established through public-private partnerships, are expected to 
be rolled out by 2008.  NASSCOM has also partnered with the 
Ministry for Human Resource Development to create the "finishing 
schools for engineering students" program to equip young 
professionals with the necessary skill sets to be directly 
employable in the IT industry.  This program will help reduce 
training costs for new entrants to the industry.  NASSCOM has 
also launched an industry standard assessment and certification 
program - the NASSCOM Assessment of Competence (NAC) - to ensure 
a steady stream of employable talent especially for the 
outsourcing sector. 
¶18. (U) In contrast, Mehta warned that a downturn in textile 
industry employment hurts a particularly vulnerable segment in 
Indian society.  The textile industry offers job opportunities 
for illiterate or semi-literate workers.  Moreover, the industry 
utilizes unskilled and semi-skilled workers and offers safe 
employment to women, he noted.  The industry is not location 
specific and can be set up even in economically backward areas 
of India, Mehta claimed.  It costs around USD 250 to create 4-5 
jobs in this industry as compared to an expenditure of USD 
12,000-15,000 for 4-5 jobs in the IT sector, he added.  For 
these reasons, Mehta argued, the textile industry, which is one 
of the highest net foreign exchange earners for India, should 
receive the same favored treatment that the IT industry receives 
from the Indian government. 
 
But Booming Domestic Economy Also Creates New Options 
--------------------------------------------- -------- 
¶19. (U) An upside to the booming Indian economy for the IT 
industry is that it has also enabled the industry to obtain more 
of its revenue domestically and thus hedge against foreign 
exchange fluctuation, Vaishnav noted.   He pointed out that the 
industry currently obtains over 20 percent of its revenues 
domestically versus under 14 percent five years ago.  He noted 
that this trend will continue as the Indian economy continues to 
 
MUMBAI 00000046  005.2 OF 005 
 
 
grow in productivity.  Vaishnav singled out the domestic banking 
industry and telecommunications industries for contributing to 
this trend.  He also believes that the organized retail sector 
has the potential to be a future driver.  In tandem with this 
revenue diversification, the industry has also started 
offshoring jobs itself in order to better service clients. 
Vaishnav pointed out that the industry has been hiring in China 
and in the European Union and is now looking to hire in Vietnam, 
Israel and the Philippines.  Atul Nishar of Hexware confirmed 
this phenomenon, called "near-shoring," and stated that his 
company had opened up a software testing facility in Mexico even 
though employees receive salaries twice as high as those in 
India, to be in the same time-zone as American customers. 
Nevertheless, he emphasized that hiring in India is still a 
smarter option because of relatively cheap labor costs given the 
skill of the employees. 
¶20. (U) Similarly, Mehta admitted that formerly export-oriented 
textile companies are quickly tuning their business models 
towards India's domestic economy.  He informed Econoff that the 
booming domestic garment industry has caused nearly all 
exporters, including himself, to switch to domestic-oriented 
operations.  Textile and clothing manufacturers are also 
investing in improving the technology used in their factories. 
CMAI stated that the industry is also looking to move up the 
value-chain into higher quality products which were 
fashion-related or technology-related like the bullet-proof 
vests and parachute parts that Econoff saw being manufactured 
during the recent tour of a textile factory in Surat, Gujarat. 
In a separate conversation, Sanjay Lalbhai, Managing Director of 
Arvind Mills in Ahmedabad Gujarat, one of India's largest 
textile companies, told Congenoff that the rupee's rise has 
forced his company to look hard at the domestic market, which is 
growing fast.  Arvind Mills has exclusive sales and 
manufacturing contracts with major foreign clothing companies, 
such as Benetton and Tommy Hilfiger, for which there is an 
emerging Indian market for higher end clothing. 
 
Comment: 
------- 
¶21. (SBU) Once the main export revenue generator of the Indian 
economy, the textile industry now struggles in the shadows of 
"new economy" exports, such as engineering goods, petroleum 
products, and the IT sector.  The textile industry traditionally 
was a huge income source for politicians and officials, who 
traded much-needed license and manufacturing permits under the 
"License Raj" for campaign funds and pocket money.  The IT 
industry, in contrast, evolved largely outside of government 
regulation and political interference, a respite for which its 
boosters are grateful.  Now, both industries find themselves in 
the same boat, facing a rising rupee that erodes profits in an 
environment of increasingly global competition.  For this, not 
surprisingly, representatives of both are turning to the 
government for help in advance of the upcoming budget session of 
Parliament.  Whether the Indian government will provide tax 
breaks or other kinds of help is uncertain; what is certain that 
once given, tax breaks and other sops are hard to take away, 
even when an industry returns to health.  In addition, though, 
both industries are also trying to diversify and restructure 
away from dependence on the U.S. market and the dollar.  Not 
every firm will succeed, especially the smaller ones, but it is 
external pressures such as these that often leave industries 
leaner and meaner.  Although fraught with political 
difficulties, the threat of huge job losses in the 
labor-intensive textile industries might be one of the best 
opportunities to push the government for more labor flexibility 
that allows re-absorption of low-skilled workers.    End Comment. 
OWEN