India's export cushion

Rising services surplus is likely to offset the goods trade deficit in the short and medium term

Some meaningful shifts have happened in India’s services economy. On a net basis, services exports are raking in $60 billion per year more in revenues than in the pre-pandemic period. This has provided much-needed relief on the balance of payments front.

And it’s not just inflation bumping these numbers up. At 40 per cent higher than pre-pandemic levels, services exports adjusted for inflation have outpaced high-tech, medium-tech and low-tech goods exports by a considerable margin.

In fact, India’s services continue to gain global market share, even as the share of goods seems to have flat-lined. 

So what’s going on? We’ve always known about India’s promising IT sector. But what’s driving the recent exuberance? The rise in revenues of the top IT companies has definitely played a role. After all, it is well known that big shifts happened in the pandemic period that were particularly supportive of higher IT spend globally. Covid-19 has accelerated front-end digital investments and multi-channel commerce for most industries, and this further re-enforced companies’ transformation of their back-end tech infrastructure to be more agile and adaptive. The cloud was core to this: Roughly every $1 spent with cloud companies led to a $3 spend on services with Indian IT companies.

But there seems to be something going on beyond the gains made by the large IT firms. “Other” IT services exports are rising faster than the revenues of the IT majors. Until about five years ago, the revenues of the major IT firms made up about 55 per cent of the overall services exports, but this has now fallen to about 45 per cent. Over the last two years, the revenues of the IT majors have grown by 12 per cent on average, while overall IT services exports have grown by 20 per cent.

What could these “other” IT services exports be driven by? One important driver could be that the mid-sized IT firms are growing well, gaining market share. In fact, in FY22, they grew about 50 per cent faster than the large IT firms.

But some other developments are also worth noting.

Illustration: Binay Sinha

A quick breakdown suggests that IT services make up about 70 per cent of overall services exports. Within IT services exports, computer services have a 65 per cent share, followed by professional and management consulting services (22 per cent), technical and trade related services (8 per cent), and research and development (3 per cent).

What’s perhaps more important than the share is the growth trends across these sectors. Over the last three years, professional and management consulting has grown the fastest, at a whopping 29 per cent compound annual growth rate (CAGR), followed by computer services (16 per cent), and research and development (13 per cent). 

The one sector that generates revenues under each of these heads, and has, we believe, contributed to the fast growth in IT services, is Global Capability Centres (GCCs) and their rise.

What are GCCs? Put simply, they are units set up in India by overseas multinational corporations (MNCs) to provide them with global tech services, research and development, engineering and IT support.

Many large MNCs have set up GCCs in India, and the number has been rising, from 1,026 in FY15 to 1,570 in FY22. In fact, India is home to about 40 per cent of global GCCs, and this ratio is only expanding.

Currently, their direct output is about $51 billion, making up 25 per cent of overall IT services exports. In the last two years (FY21-23), the output of GCCs has risen by a CAGR of 19 per cent, broadly in line with the growth in overall IT services exports.

More important than past growth are future prospects. The GCCs are expanding both in scope and depth. After starting off as providers of support functions, they have moved up the ladder, to tech enablement, business operations, capability development, and even R&D and business development.

Almost 50 per cent of the 1,570 GCCs in India provide engineering R&D support. These account for over 40 per cent of the total GCC headcount and have been growing at a CAGR of 12 per cent. An example here is the GCC set up by British drugmaker AstraZeneca, which has rebranded itself as a Global Innovation and Technology Centre, driving increased innovation. 

After a terrific run, it is possible that the pace of the increase in India’s IT services exports moderates a shade over the next year or so, in line with slowing global growth. Traditionally, weak growth years and macro uncertainties are associated with lower discretionary project spend and shorter tech budgeting cycles. We believe growth in services exports may fall from 15 per cent over the last few years to a 7-8 per cent CAGR over FY24 and FY25.

But we see no major cause for concern about India’s external finances over this period. Led by the gains from higher services exports over the last few years, the moderation in oil prices, and lower consumer imports, external finances are likely to be in a better place than last year, providing some domestic buffer to the rupee in uncertain times, and even taking the pressure off the Reserve Bank of India to hike one-to-one with the Fed.

Beyond the next two years, the medium-term outlook for IT services looks more exciting than before as tech penetration spreads across industries and the width of possibilities from GCCs expands.

India’s tech trade group, Nasscom, has a target of $500 billion in IT service revenues by FY30. We estimate that after a temporary softening in overall services exports growth in the next two years, this would require a rise back up to about 9 per cent CAGR between FY26 and FY30.

More interestingly, this means that on a net basis, exports which have risen from $6.8 billion/month in FY19 to $12 billion/month in FY23, could further rise to $20 billion/month by FY30. As discussed above, between FY19 and FY23, this provided additional revenues of $60 billion. If Nasscom’s targets come to bear, net services exports could rise by $100 billion between FY23 and FY30.

This is significant because as India’s GDP growth and investment rates rise, leading to more goods imports, the worsening of the goods trade deficit can be offset to a large extent by a rising services surplus, helping to keep external finances sustainable.

In conclusion, India’s IT sector has risen impressively to meet the world’s tech needs. This is likely to provide an additional cushion to external finances in the short run (when the Fed increases rates for longer) and also the medium term (helping fund a likely rising goods trade deficit).

The writers are, respectively, chief economist– India & Indonesia, and economist –India, at HSBC