Infosys Technologies will announce its latest quarterly results on Thursday. Its senior managers will also tell us how they expect the company to perform in the coming quarters. The big question they will have to face from journalists and analysts: how will revenues and profits be affected by the relentless rise of the rupee?

The dilemmas faced by Infosys are not unique. It is well known that a host of export industries have been struggling to come to terms with the appreciation of the rupee this year.

A sustained rise in the rupee could lead to a change in the way corporate profits are distributed. And the economics underlying this shift could also give investors useful clues about how to structure their portfolios.

Usually, a strong currency brings down the cost of imports. I recently decided to buy annual subscriptions to two of my favourite foreign magazines, partly because they are now cheaper by more than 10%. Forget magazines. Everything, from crude oil to toothpastes, that lands at Indian ports will be cheaper than before in rupee terms.

Cheaper imports will put downward pressure on local variants. Companies will have to cut their listed prices to compete with imports that suddenly boast of lower prices.

Economists talk about the law of one price—or the fact that prices of goods tend to equalize across national borders. But not everything we buy is hostage to the law of one price. It is hardly likely that the cost of a haircut or a doctor’s consulting fee will drop because of a rise in the rupee’s value against the dollar. These are services that are not traded across national borders.

High transport and transactions costs make the markets for these non-tradable services resolutely domestic. You are hardly likely to catch a flight to New York to get a pedicure because it now costs you less in rupees.

What this means is that the price of tradables will drop but the price of non-tradables will remain steady (or rise) in a country with an appreciating currency. Cheaper iPods, but more pricey music concerts.

This is an axiomatic statement. A nation’s real exchange rate is the ratio of the price of non-tradables to the price of tradables. A drop in the latter is bound to push up the real exchange rate. That could be happening in India, though I have not seen any recent research on how the relative price of non-tradables could be going up.

What should investors make of this? Price pressures in toothpastes and rising prices on hospital fees could mean that profits of companies which make non-tradable goods and services have a better chance of surviving a strong rupee. (Of course, the best companies making stuff that can easily be traded can also deal with the rising rupee by being more productive, innovative and quality-conscious.)

China is already seeing a profit shift from tradables to non-tradables. In a new research report, Goldman Sachs analysts Hong Liang, Yu Song and Eva Yi say this about the appreciation of the Chinese yuan (CNY): “As the CNY appreciates, the prices of upstream products (or tradable goods) tend to decline relatively to the prices of downstream products (or non-tradable goods). In addition, more interestingly, such a shift in relative performance seems to also have taken place in the share of profit distribution between upstream versus downstream industries."

I would not be surprised if something similar is happening in India as well. If you slice stock market returns over the past few quarters, you’ll see that investors have dumped companies dealing in tradable goods and services.

This is perhaps why automobile, pharmaceuticals, consumer goods and software companies have been relative underperformers.

And now take a look at the stars —retailing, banking, telecom and power, for example. These cannot be easily imported. Hence companies in these sectors are relatively less sensitive to a strong rupee. They are not passive price takers. Investors seem to have figured out how relative prices and profits have shifted (and will perhaps continue to shift) as the rupee strengthens.

If this trend continues—it may not —then it is only a matter of time before the grumbling about India’s de-industrialization becomes audible. Countries with strong currencies have usually seen their manufacturing companies under stress, especially those churning out low-value stuff.

The US went through this phase in the 1980s. So did Japan in the 1990s.

Indian companies, with low wages and low productivity, still have immense scope to control costs and remain competitive despite a strong rupee. But that fact alone will not be enough to silence the inevitable grumbling about how India is losing industrial strength when it should be building it.

One can almost see protectionists emerging out of the woodwork.

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