News & Analysis

Indian IT Services Growth to Moderate in Near Term

A new study claims that the global economic slowdown would result in moderate profits for Indian IT services companies

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Market research appears to be divided on the future of Indian IT companies growth over the next few months. While some predict that the global economic slowdown could actually benefit the sector, a new report runs contrary to this belief claiming that revenue growth and operating profit margins of these enterprises could moderate in the near term.

Rating agency ICRA says in a new report that macroeconomic conditions and inflationary headwinds across key markets could stymie growth of Indian IT companies though overall it continues to maintain a stable outlook for the sector in view of the healthy demand outlook especially for digital services. 

Growth momentum for the IT services companies sampled by ICRA was largely sustained in the first quarter of FY23, supported by rupee depreciation, the year-on-year growth could moderate to 12-14% due to the base effect, macroeconomic conditions and inflationary headwinds, impacting investments in technology by clients, says ICRA sector head Deepak Jotwani.

“Notwithstanding the same, operating profit margins are expected to remain healthy at ~22%. Further, the surge in attrition levels is likely to start tapering only by the end of FY23. Consequently, margins will improve over the medium-term supported by stabilization of wage costs and some optimisation of the employee pyramid, better realization, and employee utilization,” he said. 

The report also takes into account the increased training and incubation costs for fresh hires over the recent months as well as salary hikes necessitated to retain existing talent. It says, these expenses would result in a wage cost inflation that will contribute to this moderation in profit margins over the current fiscal year. 

ICRA believes that IT companies need to be focused on enhancing the share of fixed-price contracts during the period as they assure better revenue visibility and higher deployment of offshore resources at lower salaries. In addition, better utilization of manpower across projects and deployment of automation would also add to the advantage. 

The report also noted that the impact of foreign exchange fluctuations on the industry’s performance would be contingent on the movement of the rupee compared with other key currencies, mainly the GBP and the Euro. The rupee has appreciated against both over the recent quarter that implies that it takes away the gains on its depreciation against the dollar. 

“Moreover, the credit profile of Indian IT services companies remains comfortably supported by healthy internal accrual generation and strong balance sheets. Despite steady outflow towards rewarding shareholders and investments to fuel inorganic growth, the liquidity position of our sample set is expected to remain strong, aided by the availability of surplus cash and liquid investments,” Jotwani said.

The report says growth would be broad-based across all key verticals though growth in Europe has tapered off over the past two quarters due to a moderation in order inflows due to the ongoing geopolitical challenges. The report calculated that aggregate operating profit margins for the sample set fell to 23.3% in FY22 as against 24.2% in FY21 due to higher staff costs.  

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