A depreciating US dollar is fast becoming a headache for India’s real economy. Companies

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and industries that have a huge forex component in top lines are already getting nervous. The resolution of the G20 nations to allow the value of their currencies to be determined by the market has only added to this nervousness.

Loose money in the US has in a way benefitted the Indian market this year. The over 15 per cent jump in the equities indices so far this year has been attributed to the $38 billion of inflows from foreign institutional investors.

These inflows have already rung alarm bells for monetary authorities. What has added to the worries is the recent announcement of a second round of quantitative easing measures by the US Federal Reserve, which has the potential to weaken the greenback further.

“US Fed’s objective is to keep the dollar down, so that it increases US’ competitiveness and in turn raises domestic production,” said Kedar Deshpande, head of retail broking at Edelweiss Securities.

The move is expected to lead to a further surge in hot money flows to markets such as India, complicating monetary settings. One of the major reasons behind the strong inflows to Indian equities is the expectation of a sharp rise in the rupee as hedge funds can increase returns in case of a rise in the local currency.

Analysts say from the rupee point of view, inflow of more liquidity from developed markets is going to play havoc with the domestic currency. The rupee has risen 10 per cent against the dollar in the past three months, reducing net realisations of exporters. The Dollar Index has lost 13.20 per cent from its peak of 88.39 on June 8.

This spells trouble for export-oriented sectors such as IT and IT services, textiles, leather, sugar and pharmaceuticals. Even a few auto, auto ancillary, FMCG and capital goods companies have their fortunes tied to the dollar.

A quick glance at last financial year’s forex earnings data of the BSE200 basket shows one of every four companies has over Rs 100 crore in forex earnings. Out of these 50 companies, 27 have forex earnings in excess of Rs 500 crore, 19 have in excess of Rs 1,000 crore and 10 have over Rs 2,000 crore.

Apart from nine IT companies, the list has 11 pharma companies, five auto and auto ancillary firms, five capital goods companies, three from the metals and minerals sector and others such as Tata Tea and McLeod Russel from the tea sector, Great Offshore from shipping and ITC and Dabur from FMCG.

Infosys last month increased its FY11 guidance in dollar terms, but didn’t sound that optimistic in rupee terms. “In the September quarter, the stronger rupee hurt the company’s operating margin by 1.5 per cent,” chief financial officer V Balakrishnan said.

“In the December quarter, we expect the margins of IT companies to remain under pressure on account of the appreciating rupee,” brokerage Sharekhan said in a recent IT sector review.

Companies with forex earnings use hedges to protect their revenues from currency fluctuations. But hedges do not work when the long-term outlook of a currency turns negative, which is somewhat the case with the greenback.

Vihang Naik, analyst for IT services at MF Global Sify Securities, said IT companies generally keep hedges for two quarters of their net receivables (future earnings - future costs). “The total hedge amount is not very big. We have not seen companies adding more hedges,” he said.

Tarun Sisodia, director and head of research at Anand Rathi Financial Services, said he has been neutral on the IT sector in spite of some good numbers in the second quarter. “Going forward, revenue growth will be impacted strongly by the rupee appreciation. Also, there are concerns over tax rates, slow recovery in the US, margin pressure and higher employee cost,” he said.

However, he didn’t think the impact would be as much in the pharma sector. “The drivers will be slightly different here. Companies that sell generic drugs and out-of-patent formulations outsource their products. Thus, the net impact will be less,” he argued.

Forex revenues form the bulk of the top line for most pharma companies. For instance, it is 83 per cent for Dr Reddy’s, 77 per cent in case of Ranbaxy, 60 per cent for Sun Pharma and 54 per cent for Cipla.

“The rupee appreciation will strongly impact companies with net export earnings, something like textiles for instance,” Deshpande said. In the textiles space, companies such as Arvind, Raymond, DCM and Gokaldas Exports have 20 per cent to 85 per cent of their earnings in forex, most of it being from the US and other European countries.

There are side-effects too. A weak dollar is recipe for a spurt in commodity prices. “We may also see a hike in metals and crude prices in the short run. Crude prices may move up to $90 a barrel anytime soon. This could hurt downstream companies,” said Jay Shankar, executive vice-president and chief economist at Relifgare Capital Markets.

Higher commodity prices will cut into margins of a host of downstream companies, including those in the auto and FMCG sectors.

What is more, commodity prices have an inverse relationship with that of equities, which suggests a sluggish period ahead for the equities market. For an economy already reeling under double-digit inflation, a spurt in commodity prices may change many equations. However, oil companies that are into both upstream and downstream businesses — such as Reliance Industries and Essar Oil — are going to gain from an appreciating rupee. A weakening dollar will also be favourable for many capital goods companies, which import equipment from abroad.

Economist Indranil Pan of Kotak Mahindra Bank looks at the situation differently. “Out current account is quite wide. This is going to eat up a lot of foreign inflows. And the net result would be for a depreciation of the rupee,” Pan said.

He said the rupee’s bias would be towards depreciation in a one-year perspective. “Towards the second quarter of 2011, we expect the credit crisis in the euro zone to blow up once again. The greenback may turn up at that point,” he reasoned.

Some market experts say the first signs of any strengthening of the Dollar Index could halt FII inflows, mainly because of the fear of a decline in the rupee. This will lead to a correction in commodity prices. They advise investors to keep a close watch on the Dollar Index as well as rupee movement to get an early indication where the equity market is headed.