Search for growth

Tech sector is adjusting to the post-pandemic world

Since January, the Nifty IT index, which tracks the 10 largest listed infotech companies, has lost a whopping 29 per cent. The Nifty has gained 1.5 per cent over the same period, and the rupee has dropped a little over 7 per cent versus the US dollar. This combination of a falling rupee and a falling IT index is unusual. Investors view Indian infotech as a hedge against rupee depreciation. But the rout of tech stocks is a global phenomenon in 2022. The Nasdaq 100, which is the global tech bellwether, is down by 25 per cent this year, and unicorns have plummeting valuations. Listed start-ups like Paytm and Zomato have collapsed, while unlisted start-ups are finding it hard to get the juicy valuations commonplace in 2021. The global environment has turned bearish with downgrades to growth estimates everywhere. Inflation has been driven partly by spikes in energy prices as a consequence of the Ukraine war.

Central banks are tightening monetary policy. The Federal Reserve has adopted a hawkish stance to curb US inflation. The European Central Bank has also hiked rates. So has the Reserve Bank of India. This is likely to affect global growth. China’s lockdowns have also caused a steep plunge in the country’s economic activity and led to gaps in global supply chains. Tighter money is a big blow for the start-up ecosystem. Higher interest rates lead to “risk-off” attitudes, and private equity and venture capital are not immune to broader conditions. But investors have turned cautious not only about start-ups — highly profitable giants like Alphabet and Meta have also suffered deep corrections.

In India, the IT services sector is also suffering because of currency market volatility. The euro and the pound have lost ground against the rupee, which means the cushion of currency depreciation doesn’t exist for IT revenues from the EU and Britain. Internally, the IT industry continues to suffer from high attrition, forcing them to hike compensation. Since employee costs are a big component of expenses, this has led to margin pressures, and that’s something managements have been complaining about for several quarters. Every IT and tech company with a significant European exposure has released advisories flagging slowdowns in Europe. This was already evident in Q1, 2022-23, and the situation worsened in Q2 as Russia cut gas supply. Given the cascade of negative trends, the sell-off is not surprising. However, investors may also want to take note of several mildly positive developments. While discretionary IT expenditure may be deferred, companies looking for short-term efficiency gains are also spending in relevant areas.

Most IT services companies claim their deal pipelines are intact, and most India firms have maintained their full-year earnings guidance, though they have also cautioned that revenues will come in at the lower end of estimates. Some companies are also claiming they see churn easing in the second half of this fiscal year. This is partly due to less demand for software engineers from the cooling start-up space. One could argue that there are long-term structural trends, which ensure discretionary IT expenditures have been deferred, rather than binned. The movement towards the cloud will continue; so will digitisation since the pandemic-driven work from home paradigm is here to stay. Start-ups that can adjust for the slowdown will survive this phase.