Monday, December 28, 2009

Currency-basket based salaries

One of the issues for Indian IT services companies is that while most of their revenues is earned in foreign currencies (mostly US dollars and Euros), a major portion of their expenses is incurred in Indian rupees. This leaves their margins susceptible to currency fluctuations - if Indian rupee strengthens against dollar, their profits go down and if Indian rupee weakens, profits go up. To offset this effect, they resort to currency hedging.

But, imo, that is a suboptimal solution. There are bound to be losses in hedging and also they end up spending too much time in managing all that. A better solution would be to align their expenses (particularly salary expenses) in terms of the currencies in which they earn their revenue. Let's say a company's revenues are 60% USD, 20% Euro and 20% Yen. Then they should structure their salaries also in the same proportion. So, let's say, they decide to fix an employee's salary at Rs. 1,00,000 per month. Instead of specifying the salary in rupee terms, they can fix the salary in the three main currencies which consitute their revenues. So, it will be (USD 60,000/dollar-rate + Euro 20,000/Euro-rate + Yen 20,000/Yen-rate). And then convert each component to local currency based on prevailing exchange rate and pay the salary. If the currencies fluctuate, salary also varies in terms of local currency, but the profit margin remains unaffected.


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