IT's troubled times

The information technology industry is one of the few sectors that has been out of favour during the ongoing bull market. Since the Brexit referendum in late June, the Nifty 50 index has risen by 8.5 per cent, but the IT Index has fallen by 5.5 per cent. Five Indian infotech majors - HCL Tech, Wipro, TCS, Infosys and Tech Mahindra - were specifically mentioned among the 30 global businesses most exposed to an adverse Brexit impact. The referendum triggered a sell-off as analysts feared that US-based Indian infotech firms would lose access to the European Union (EU) market. Several infotech firms have cut projections for 2016-17, citing not only Brexit but also concerns about the deceleration in US growth and soft demand in the EU, Japan and China. Apart from cyclical factors, the industry landscape is being affected by rapid technological changes. Infotech service firms will have to retool their business models and this could mean some wobbles in revenue and profitability.

None of India's five largest infotech firms managed double-digit revenue growth (in dollar terms) in 2015-16. After delivering disappointing first-quarter (April-June 2016) results, most of them either explicitly pared their projections or issued warnings that growth might decelerate. For example, Infosys' April projection of revenue growth for 2016-17 ranging between 11.5 per cent and 13.8 per cent was in July lowered to a "best case of 12.3 per cent". Vishal Sikka, the CEO and MD of Infosys, has warned that further downgrades are possible. Infosys has suffered a human resource churn with senior personnel being switched around and this could be a factor in the poor results as well. Other majors have also been hit. India's largest software exporter, Tata Consultancy Services, is expected to grow slower this year as customers are slashing budgets and reducing project sizes because of global uncertainty. For the first time, the company could also miss its margins projections of 26-28 per cent this year, as visa fees and wage hikes add up to its woes. After TCS indicated that the growth in the second quarter of the fiscal will not be strong, owing to slowdown in discretionary spending by US clients, Cognizant also followed suit, citing challenges in financial services and health care projects, and Wipro's profits shrank in the first quarter.

The global downturn has meant that banks and insurance companies, which contribute 25-40 per cent of information technology revenues, are investing less. Legacy lines such as managing servers and developing applications are also being phased out. Automation, artificial intelligence (AI)-powered platforms and cloud computing have reduced the labour cost arbitrage and put the traditional outsourcing model under pressure. As of now, new digital lines such as cloud computing, mobility and social platforms are not generating enough revenue to offset all the contractions in banking.

The bigger problem is the duration of the slowdown, which is expected to continue over the next one to one-and-a-half years at least. A report by broking firm UBS has highlighted that the near-term demand outlook has clearly deteriorated, with increasing concerns voiced over IT budget cuts in 2017. There is also greater acknowledgement of medium-term revenue growth issues because of smaller deal sizes and on-going pricing pressure.

It's not that Indian infotech firms are doing nothing. They are making investments in AI, mobility, and automation, as well as forging partnerships with cloud computing firms and innovative start-ups. But it is now clear that industry association NASSCOM has to review its 10-12 per cent growth estimates for 2016-17.