INDIAN IT FIRMS BRACE FOR US SLOWDOWN

Rajesh Menon
The Financial Express

As fiscal 2007-08 comes to a close, there is a feeling of uncertainty in the IT sector. The reason: a slowdown in the world’s largest economy, the US—the Indian IT industry’s biggest revenue generator. Tier I offshore firms—Tata Consultancy Services (TCS), Infosys Technologies, Wipro Ltd and Satyam Computers—are all keeping a close watch on where the US economy is heading, with a strange mix of cautious optimism and bullishness. Recently, the country’s largest software exporter TCS came out in the open and said two of its top 10 clients might show subdued demand in the fourth quarter of the current financial year. Similarly, IT bellwether Infosys has projected a muted quarter. On the other hand, Wipro and Satyam have been bullish and have expressed comfort with the near-term demand.

“The near-term impact of the slowdown in the US market is going to be for both big and small players. There is still uncertainty over clients’ budgets and visibility is expected only by the month-end or early April. It is not just the BFSI that is taking a hit, it is even affecting other verticals like retail and manufacturing,” says an official of a Tier-I company. “There have been price increases and also renegotiations have been successful. But volumes may be muted. Also large projects may get delayed,” says a top official of an IT company.

At the end of the third quarter, the top IT companies had all admitted that IT budget decisions by the US corporate houses were getting delayed, especially in the banking, financial services and insurance (BFSI) segment. They had expected a clearer picture by January-end or early February. The worry lines have begun to emerge as the decision-making process has gotten prolonged and their potential clients continue to be on a wait-and-watch mode.

With the BFSI segment contributing nearly 40 percent revenue to the top IT firms, any adverse impact on discretionary spending by the large financial institutions and global banks will be a drag on their fortunes. But what is reassuring is that, in spite of the near-term demand being less visible than earlier, and an increased competition to Indian players from global peers, offshoring as a trend continues to be attractive.

Recently, a top team of global investment bank JP Morgan met 15 IT and BPO firms and interacted with various players in the offshoring industry. It found that secular trends towards offshoring remained resilient. “While the overall IT demand may be tighter than previous years and could create a rough patch for stocks near-term, we share the consensus view that the offshore demand will increase in response to a slower environment and drive-acceleration in the second half,” the report said.

In 2001-03, during the post-tech boom and the dotcom crash, the Indian IT industry had gone into a sluggish phase following lower demand from the US corporates and had to cut rates leading to impact on margins and lower profitability. But, this time around, the players are better prepared for the slowdown. “Most companies have employed more variable compensation, while there is still flexibility in general and administration (expenses), utilisation, headcount and increasing productivity. Helping matters is the more rational pricing versus the last slowdown,” the report said.

There are four main inter-linked factors that have had a direct impact on the Indian IT industry’s competitiveness— the rupee appreciation, the tight labour supply and wage inflation, and macro issues. Compounding these is the vanishing tax holidays for IT firms in March 2009. The rupee appreciation against the greenback—nearly 10 percent in 2007—has adversely affected the margins of the Indian IT players that have taken a hit of 0.4 percent to 0.5 percent and have been unable to pass on the impact to their clients because of the deteriorating macro-economic situation. Although most companies have hedged the rupee against the weakening dollar, in the long-run, unfavourable currency appreciation may put pressure on earnings.

The supply of labour and wage inflation are directly co-related. With demand surpassing supply, wages have been rising 15 percent annually. Apex software companies’ body Nasscom estimates an annual supply of 200,000 engineers, 24,000 MCAs, 30,000 post-graduates and 350,000 graduates. Currently, there are 1.6 million technical professionals employed in the IT industry and Nasscom estimates that the number will grow 25 percent this year to touch two million. But the lack of quality talent is quite alarming. Only 15 percent of the non-engineering graduates and 50 percent of the engineering graduates are employable. This has forced Companies to open their purse strings to get the best of the lot.

As costs have piled up, India’s edge as a low-cost offshore provider has started diminishing, with other countries trying to close the gap. Indian IT companies have to go in for cost-beneficial strategies that would help them maintain profitability. The slowdown would also catalyse the emergence of winners and losers, with companies going in for a hybrid model— onsite or near-shore delivery with offshore presence—likely to emerge the winners.

So, what has made the industry observers and analysts to be optimistic about offshoring in difficult times? It is the adaptability of the Indian IT firms to the hybrid model and also to embrace different service lines and go in for geographic diversification that has a big positive impact on the industry. For instance, Indian firms looking to offer remote infrastructure and management to compete with its global peers and also looking beyond the Indian labour market to eastern Europe, Latin America and China would help them to sustain their revenue graph. Also, with uncertain global macro-economic environment, wage inflation may ease during 2008 as Indian firms reduce hiring and increase utilisation rates, while global IT majors show a reduced sense of urgency in ramping up their India operations.

So, even as there are concerns and fears of a slowing economy and a potential negative impact for Indian firms due to a cut in IT spending, the impact is expected to last for a short-term and may actually result in an increased offshoring in the long-run.