The Indian IT services exports industry was pegged at $50 billion in 2013-14. After growing at a robust pace of 17-18 per cent until 2011-12, growth slowed down to 11-14 per cent in 2012-13 and 2013-14 amid lower discretionary spending across companies.
The industry has shown signs of recovery in volume terms in 2013-14 and 2014-15 due to greater need for regulatory compliance in the banking and financial services sector (example: the Dodd-Frank Act and the Fair and Accurate Credit Transactions Act), increase in offshoring by emerging verticals such as retail and healthcare and adoption of new technologies such as social, mobility, analytics and cloud. But, billing rate pressures continue in a highly competitive environment, even as global economic growth is perking up. Consequently, CRISIL Research forecasts the industry growth rate to remain below 15 per cent annually over the next two years.
According to the disclosures made by Tier-I IT companies, volume growth (in terms of man-month billing) bottomed out since the second half of 2012-13. CRISIL Research expects that growth in volumes will be the only means for Indian IT companies to boost revenues in the medium-term. Mid-tier players have lagged larger players in overall revenue growth recovery in the past few quarters. Taking into consideration the interactions with players and their guidance, CRISIL Research expects mid-tier players to grow faster than Tier-I players in the second half of 2014-15 (over a low base). Tier-I players grew by 12.5 per cent in the first half of 2014-15, while mid-tier players grew by around 7.5 per cent on a year-on-year basis in dollar terms. However, Tier-I players, who have registered healthy growth rates in the first half, are not confident of growing faster in the second half due to softness in insurance and retail segments.
In the first half of 2014-15, the impact of wage hikes and stable billing rates was offset by the benefits arising from the rupee’s depreciation (by around 2 per cent against the dollar) and improvement in employee utilisation (by around 280 bps) resulting in net improvement of around 95 bps in margins. In the second half of 2014-15, CRISIL Research expects margins to take a hit of 150-200 bps in the absence of benefits arising from the rupee’s depreciation; in fact, the pressure on profitability is already evident in the results for second quarter of 2014-15.
For Tier-I players, margins improved by close to 100 bps in the first half of 2014-15. However, for mid-tier players, margins have been declining steadily, and they continued to reel in the first half of 2014-15 as utilisation levels did not improve. CRISIL Research expects the overall industry’s operating margins to drop in the second half and more sharply for mid-tier players. Thus, large IT service players’ operating margins could erode by 50-100 bps, whereas mid-tier players’ operating margins could see a steeper erosion of 150-200 bps in 2014-15. The CRISIL Research’s base case scenario assumes that the rupee will average 60 a dollar in 2014-15 from an average of 60.5 in 2013-14.
CRISIL Research believes that stabilisation in billing rates, improvement in global macroeconomic conditions and hence, discretionary spending will help margins stabilise across most players in 2015-16. The proposed Immigration Bill in the U.S. has been passed by the Senate and is pending with the House of Representatives.
In case the proposed bill becomes a law without any further amendments, it will have a significant impact on Indian IT vendors’ recruitment process and employee cost, thus, impacting profitability.
CRISIL Research interactions indicate that increased proportion of local employees and higher visa fees have the potential to impact Indian vendors’ operating margins by anywhere between 300 and 400 bps.
Over the past few years, Indian IT services companies have been focusing on non-linear revenue sources. These efforts are yet to gain traction, and consequently, the contribution of non-linear services to the revenue pie of the industry remains relatively low at 8-10 per cent. Nonetheless, CRISIL Research expects the investments being made by Indian IT services companies in this arena to bear fruit in the years to come.
Concurrently, companies have been increasing utilisation levels and using automated platforms to drive higher productivity per employee. So, increasing focus on non-linear services and automation, along with the pressure on billing rates, will impact hiring by IT services companies.
(The author is Director, CRISIL Research)
