India's IT sector could feel pain from tightening of purse strings by banking, financial clients

This week, a Kotak Institutional Equities’ analysis of earnings calls by European and US companies served as a grim reminder of things to come. Apart from banking and financial services (BFS) clients lowering their budgets and the external environment taking a negative turn, the biggest cause of concern was that overall technology investments are expected to be lower than last year.

Trade war and Brexit could impact the Indian information technology (IT) sector, the majority of whose clients come from the BFS industry. The UK economy itself has shrunk by 0.4% as the Brexit paralysis took over. The analysis also showed that UK’s industrial production declined by 2.7% over the month and manufacturing slumped 3.9%.

All of these clearly spell out bad news for the IT market, including India. Other factors include uncertainty around central bank policy and interest rates and speculation of a shutdown of the US government.

Although the outlook for April was much better than that for January, February and March, the long view of 2020 and even 2021 does not cheer.

Morgan Stanley, at the start of 2019, had said a lot of negativity was building through the end of the year.

“There's very little pure discretionary stuff you can just stop. But if you are going to make a real move, you've got to be quite strategic about it,” it said.

The US immigration-tightening policies have also led to a new trend of Indian IT services setting up centres and campuses in America. The latest opening was of a technology centre by Tech Mahindra in Missouri.

Around June 2018, BFS firms were over the moon as the interest rates were high and rising, US global economic growth was strong as was the confidence of corporates and investors. An added benefit 2018 had was no hints of an upcoming trade war.

As a result, BFS firms made plans to increase investments in newer technologies, better customer experiences, digital platforms driven by data analytics and a host of other investments.

However, the mood currently points towards maintaining a steady business instead of focusing and experimenting with new methods and technologies.

“We believe that BFS companies on an average placed greater priority on cost management initiatives at the start of 2019 as revenue visibility was low in an uncertain environment,” said Kotak’s report.  

The focus on expense management could have impacted tech spends. The biggest worry for the Indian IT market is with the planned cost-cutting measures that could adversely impact technology spends, taking a toll on revenues of IT companies in the March quarter.

Silver lining

Perhaps one of the silver linings for the IT industry was software services giant Accenture increasing its revenue growth forecast figures for the new financial year starting April. It had increased its revenue projections from 6-8% to a modest 6.5-8.5%, which the company claimed came from a foreseeable demand for digital and cloud technologies. 

Kawaljeet Saluja, head of research at Kotak, who also authored the latest report on the expected negativity in the BFS domain, had earlier said, "We expect Infosys, HCL Technologies and Tech Mahindra to grow faster in 2019-20 than the previous financial year (2018-19). Growth will be led by a ramp-up of large deals won by companies over the past two quarters. All companies reported a strong deal flow for the December 2018 quarter."

Saluja had made the statement in a note to investors and media, ahead of the full-year results of major IT firms, which all reported moderate growth figures.

Another positive is a report by ratings agency ICRA, which had forecast that the Indian IT services and consulting industry will grow 7-9% in dollar terms during the next financial year starting April 2019.

The report said that demand for IT services will be stable, although visa issues and increased onsite hiring in the western markets would put pressure on profitability. The report also said that currency benefits would mostly compensate for any loss in profitability.

ICRA’s sample size was only 13 IT companies, which had grown 19.4% on average for the third quarter of 2018-2019.