Headwinds from the West

Weakening global discretionary spend makes IT industry cautious

The results of the Indian IT majors have largely matched the consensus expectations for the quarter ended June 2022 (Q2, FY23). However, the management guidance in most cases shows a certain degree of caution, and firms admit to the deteriorating macro environment, which could hurt demand. In addition, industry-specific attrition rates remain elevated, with all the majors experiencing well over a 20 per cent churn in personnel. The operating margins are expected to be more or less flat through the second half of FY23 despite some improvements in Q2. Despite the weakening rupee equation versus the dollar, the revenue guidance has not been upgraded. Many IT businesses seem to be paring their revenue and operating-margin expectations to the lower end or mid-point of the assessments in July-August, when they declared their Q1 results.

On the bright side, most IT firms’ managements say that attrition rates are stabilising and are likely to ease in the second half of 2022-23. This is due partly to the cooling off in the start-up space, which was creating highly-paid jobs for coders. However, sub-contracting costs still remain high, indicating that the labour market is tight. The broader commentary around the Q2 results also claims that there has not been any serious tailing off in demand for the IT industry so far, but margin pressures could be building up. Among the IT majors, HCL Tech, which has an unusually high exposure to the infrastructure segment, is the only one that is guiding for a strong revenue expansion, or strongly rising margins. The other majors are guiding for maintaining their earlier projections or for some margin pressure.

Historically, the Indian IT services firms have always been seen as high-growth players in North America (where they earn over 65 per cent of their revenues). In addition, the industry is seen as a dynamic hedge against a weaker rupee due to the fact that the earnings are largely in hard currencies, while much of the costs are absorbed in rupees. However, the macro situation is currently unusual: The dollar has gained against all currencies and, in fact, the rupee has strengthened against the euro and the pound since it has lost less ground against the dollar. Thus, quite apart from weak growth in the EU and UK, the rupee strength is likely to impact revenues from those regions adversely.

Among the big four, Wipro, TCS and Infosys have all reported rupee revenue growth of 4-6 per cent, which is flat in relative terms once inflation is taken into account. HCL Tech has done better. While TCS has reported high deal wins, it has also cautioned that timelines for new business orders may be “elongated” due to macro conditions, and it has pointed especially to weaknesses in the EU environment. The Infosys management commentary flags continued weakness in the mortgage and retail verticals, (both already mentioned as weak in Q1) and now in telecom and hi-tech. Wipro has mentioned there’s a slowdown in business from the hi-tech client segment. However, media, life sciences, and BFSI (banking, financial services, and insurance) are still showing positive growth.

Historically, growth patterns in the IT industry have usually been correlated with global gross domestic product growth. However, there have been periodic bursts of growth during structural changes such as the Y2K changeover and, more recently, in the movement to the cloud, and the implementation of digitisation of processes across sectors. While those trends still remain in force, companies could cut back on discretionary spending in inflationary and recessionary conditions.