No double digit growth for Indian IT services firms for next 3 yrs: Report

While appreciation of rupee against US dollar and tightening of H1B visa norms impacted the performance of the Indian IT services companies in the Q3 of FY 18, the trend is expected to continue at least for a couple of more years. According to a report by credit rating agency ICRA, Indian IT services companies are expected to register a compounded annual growth rate (CAGR) of mid-to-high single digits for the period FY2017-2020, while the price led competition is also likely to intensify further and negatively impact margins for the industry.

The aggregate growth of Indian IT services companies (based on data from 14 sample companies) was at around 4.2 per cent (8.8 per cent in US$ terms) during Q3FY2018 compared to CAGR of 17.1% experienced over the FY2013-2017 period and a 9.7% growth in last fiscal (FY17).

The lower growth in Q3FY18 was also due to the Rupee appreciating by approximately 4 per cent versus US dollar during the quarter.

“While companies have increased spending on digital technologies and awarding new contracts, the overall IT budgets have moderated leading to lower incremental spends. The share of Indian players in Global IT Sourcing market stood at 67 per cent in CY2016 (60 per cent in CY2012),” said Gaurav Jain, Vice President, ICRA.

However incremental gains are expected to be at a slower pace. Indian IT Services companies are in the midst of re-orienting their business models focusing more on higher-end services such as IT consulting and emerging technologies (digital), he added.

Equity research firm JP Morgan had also noted a few weeks earlier that year-on-year equity growth rates can continue to inch up in the next three quarters before levelling between high single digit to low double-digit percentage terms.

These Indian IT players have made considerable progress so far, though they still lag behind international peers. ICRA expects large Indian IT companies to grab a higher share of the digital services space over the next three years.

The Manufacturing verticals outperformed other key verticals with 5.8 per cent growth in Q1FY2018 and 3.6 per cent in Q2FY2018 led mostly by automation which includes internet of things (IoT), analytics, optimising supply chain and enhancing distribution channel effectiveness.  

Banking, financial services and insurance (BFSI) sector continues to remain a pain point even as insurance has picked up. Demand for BFS sector has been adversely impacted by current macroeconomic conditions impacting the industry including sustained low interest rates and weakening of British Pound as a result of Brexit referendum.

The insurance sector has seen good growth and is supporting the overall growth for BFSI which contributes 30 per cent of ICRA’s sample set revenues, noted ICRA. So far only TCS out of the top four IT companies has maintained a wait and watch approach on BFS.

Industry’s operating margins have moderated from 24-25 per cent to 23-24 per cent over the last few quarters, said the report. Increased scrutiny on H1B visa applications is also likely to negatively impact the margins of Indian IT Services companies as it will not only increase compliance cost but also deter companies from higher reliance on such visas leading to higher onshore hiring, they said.

While the industry is driving efficiencies through the deployment of operating levers such as higher share of fixed-price contracts, lesser idle resources and increasing automation, the presence of both local and international players in the market will negatively impact margins, said ICRA.

The report, however, noted that the credit profile of Indian IT Services companies is expected to remain stable underpinned by its ability to sustain free cash flows despite pressure on revenue growth and margins. “Free cash flows are expected to remain healthy, though there could be moderation in the quantum of such cash flows.”

ICRA expects consolidation in the industry especially among small and mid-size players as margin pressure will intensify leading to lower returns for shareholders. Geo-Political issues restricting movement of skilled labour or increase in minimum salary requirement too will have a negative impact on the sector outlook, the report said.