India's IT services sector is likely to see growth slow to just around 8-10% this year compared to 18-19% in the past two financial years, said CRISIL Ratings, attributing the slowdown to geopolitical risks and inflationary headwinds in the US and Euope.
The Indian IT services sector is driven mainly by exports at nearly 85-90% revenue share with the Banking Finance Services and Insurances (BFSI) posing as the largest revenue contributor.
While the COVID pandemic had led to a dramatic spurt in demand for IT services across the globe, the segment is currently seeing a sharp deceleration in demand due to risk aversion by clients. Companies in the US and Europe have cut down on discretionary spends due to higher interest rates — spurred by rising inflation — and softness in consumer spending, mortgages, asset management and investment banking.
The Indian IT services industry remains dependent on the US and EU— the regions constitute nearly 86% of revenue share— with export growth mapping the GDP growth rates in these regions.
“Healthy growth in these regions in the past two financial years led to their revenue share rising to 86% in FY2023 and 84% in FY2021,” said the rating agency.
The anticipated moderating demand from these key regions due to macroeconomic headwinds will weigh on growth this financial year. However some improvement is likely in the next financial year, it added.
"In the last fiscal year the revenue growth of the IT sector was supported by the depreciating rupee against the dollar," noted CRISIL analysts.
For example, if an IT firm marks a deal with an US based compay for 500 dollars and at the time the rupee value is at 70 the company would is expected to receive a remuneration of Rs 35,000. However, with the depreciation of the rupee the value of one dollar is now at Rs 80, the company would get Rs 40,000 for the same deal.
“However, currency tailwinds seen in the last financial year are not expected in this fiscal year which again will impact revenue growth,” the analysts noted.
"The slowdown will be more visible in banking, financial services and insurance and retail," said analysts.
Moreover, a cut in spending is further visible among the clients, although a complete drying up is not expected.
“Clients across multiple sectors will continue to spend on IT services but at a slower rate, amid focus on cost efficiencies. They are pausing discretionary projects and spends on IT transformation,” it said. “Demand from manufacturing, healthcare, communication and media sectors will continue to remain strong with cost optimisation and efficiency through increased adoption of digital solutions, cloud and automation to provide support,” the report added.
Employee costs moderating with prudent hiring
"The operating margin will recover from the decadal low in the last financial year on moderating employee cost because of lower net addition and subcontracting costs,” noted analysts from CRISIL ratings.
With the anticipated slowdown, the It industry is expected to go slow on advanced hiring this financial year. Hiring at the middle and upper levels will also see muted growth in the next 4-6 quarters.
“Full-year impact of decadal-high net addition at elevated compensation levels in FY2022 led to high employee cost, dragging operating margin to a decadal low. However, with prudent hiring profitability per employee to improve this financial year ,” it said.
“Operating margin to improve by 3-4% to nearly 22.3% this financial year but will still remain pre-Covid levels of 23%,” it added.
Meanwhile, attrition rate has reduced in recent quarters from the peak of nearly 23% in the first half of FY2023, but it still remains higher than the pre-pandemic average.
IT service providers are also reining in rental costs and eying office spaces in Tier II cities to cut down on costs. With more employees returning to office, aggregate rental cost has increased from FY2021 low, but remains below 1.2% of the revenue.