Dollar's Dive Dents Infosys

Investors fear the rupee's rise will shrink future profit.
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SAN FRANCISCO -- Investors unloaded shares of India-based tech services giant

Infosys

(INFY) - Get Report

on fears that the dollar's weakness will crimp the company's profitability.

Shares were recently trading down $2.96, nearly 5.5%, to $46.59, after India's currency, the rupee, approached a nine-year high against the dollar. The rupee has risen about 11% so far this year.

Further frustrating investors, India's central bank continues to sit on the sidelines, refusing to buy dollars or take other measures that would stabilize the rupee's appreciation.

"The Indian central bank has been conspicuously absent from intervention in foreign currency markets," says Ashish Thadhani, senior vice president of research for Gilford Securities. Gilford has not performed investment banking work for Infosys in the past twelve months, and Thadhani does not own the company's shares.

The rupee closed at 39.91 to the dollar, breaking the 40 barrier above which it had stabilized in recent weeks. The

Federal Reserve's

decision earlier in the week to cut the rate on overnight loans between banks by 50 basis points likely fueled the rupee's surge.

Analysts estimate that every 1% gain the rupee makes against the dollar squeezes Infosys' operating profit margins by 0.2 percentage points. That's less than the estimated 0.5-percentage-point impact on the operating margins of fellow Indian IT services provider

Cognizant

(CTSH) - Get Report

, which has a greater portion of its staff located in the U.S.

Cognizant shares were recently trading down $2.42, or more than 3%, to $73.18.

Currency appreciation and wage inflation have dogged the Indian firms for the past two quarters. As demand for outsourcing services increases, IT service providers from both the U.S. and India have bid up wages for network and software engineers as they scramble to increase their workforces in Bangalore and other Indian IT centers.

Infosys has been the most active among its peers to hedge against currency appreciation. Cowen analyst Moshe Katri attributes most of Infosys' first-quarter earnings-per-share growth to currency hedges. Katri doesn't own shares of Cognizant, but Cowen makes a market in its stock.

Infosys has also tried to offset the rupee's rise by shifting more work to India, rather than performing it at a client's site. This helps to increase the usage of offshore employees that might otherwise be idle.

But investors are clearly worrying that the trends pushing up the rupee and local wages will persist for years as India's economy continues its rapid growth.

"We think these companies can absorb small currency headwinds, but the longer term trend is worrying," says Thadhani, referring to the India-based IT outsourcers.