Q4 results decoded: Several quarters of pain ahead for Indian IT

Some analysts say TCS could see 300 basis point hit on margins if H1B visa rules tighten as expected

Along with the USA, Singapore, Australia and New Zealand are also tightening work visa requirements. The UK is also tightening up its visa regime and headed into Brexit as well. This will have a negative impact on Indian information technology (IT) services. 

Events like this are hard to model. Nobody can provide a clear blueprint for Brexit’s progression and impact, for instance. Similarly, nobody knows how tight visa controls will get. Some analysts say that TCS could see a 300 basis point hit on margins if American H1B visa rules tighten as expected. But, that estimate may have a large error margin each way. Incidentally, both Infosys and TCS have been accused of gaming the US visa system by the White House. 

So far, the Q4 (March quarter) results present a downbeat picture for IT. TCS saw slower growth than it has experienced since 2008-09. Infosys missed its guidance for 2017-18. TCS has maintained its forecast on margins for 2018-19, but it saw a sequential drop in revenue for Q4, 2017-18 over Q3 2017-18. Both majors have cut back hiring.

One problem is a slowdown in investments by the global banking, financial services & insurance (BFSI) industries. Most Indian IT services outfits derive a large chunk of revenue from BFSI. The Trump administration is expected to announce large policy changes, which will presumably drive the next set of investments by BFSI.

Another problem, possibly temporary, is a strong rupee. If rupee doesn't weaken, rupee-denominated returns will fall. A strong rupee will also negatively affect competitiveness of IT services (and of other exporters). 

Beyond these problems, there's the need for Indian companies to reboot into a new environment where the Cloud, Artificial Intelligence (AI) and “Digital” have changed all the parameters. In public forums, much of the Indian IT industry remains in denial about this situation, but the writing is on the wall for anybody who cares to read it. Vishal Sikka has spoken about this but anaemic growth implies that Infosys has not yet reworked its mode of operations. TCS claims 29 per cent rise in Digital revenues which implies it is doing something right.

The Cloud drastically reduces need for manpower. Artificial Intelligence also cuts down sharply on the need for low-level staffing. Programming and debugging is much easier - it’s possible to cut and paste code from multiple sources and to debug most code without human intervention. Low-level manpower is precisely where Indian IT firms have an edge.

Infrastructure is another problem. India has poor telecom infrastructure and it's not going to get better soon since the telecom industry is mired in debt. Internet speeds are slow compared to other nations and power supply is dodgy. Lease lines and reliable power are both expensive. These are constraints if the IT industry is looking to offshore from India and thus circumvent tight visa regimes. 

There is also a big question mark about skills. The IT industry has always complained that entry-level engineers are not well-trained or capable of doing basic tasks with acceptable competence. Now the competencies have to change and re-skilling will be more difficult.  

We're seeing the beginning of the next cycle of creative destruction in a fast-changing industry. Margins are falling; hiring models must change; growth isn't visible. Companies must enter the new areas such as machine learning, data analytics, Internet of Things, AI, as soon as possible. It’s not obvious which firms will be winners and it’s very likely that some winners aren't even listed at the moment.  

Given all this, the industry could see several more quarters of being sold down. There will be a rebound but it could occur in surprising ways, to the benefit of companies that are not being tracked at the moment.