The Indian IT services sector faces several structural challenges, including declining growth rates and increasing competition from global players and domestic captives, according to Sumeet Jain, India Technology Senior Research Analyst, CLSA.
CLSA turned “cautiously optimistic” over the sector just a couple of days back, largely because of the US election outcome.
“If you recall from 2017-18, corporate tax cuts led to a significant increase in discretionary spending. This time, however, the tax cuts are expected to be less substantial (likely reducing from 21% to 15%) and the timing remains uncertain. While it won't have the same dramatic impact as before, it is still a positive development for the sector compared to a scenario where the Democrats had won,” said Jain.
Structural headwinds prevail
“After the advent of SMAC (Social, Mobility, Analytics, and Cloud), incremental spending on software within the overall tech budget has been much higher than IT services,” said Jain. The IT services segment in India, he said, has been shrinking over the last six years, with software spending growing at double or triple the pace of IT service companies globally.
The rapid adoption of AI and generative AI is expected to further accelerate software spending. This remains a structural headwind for the sector,” said Jain.
A second headwind for the sector, according to Jain, has been the plateauing growth in IT services exports. Indian IT services exports, which grew from 4 percent of global IT services spending in FY06 to nearly 16 percent today, have plateaued in recent years. “Over the last three years, penetration has flattened, and we believe it will remain at 16-17 percent levels for the foreseeable future,” he said adding that the IT story in India is no longer the penetration story it was a decade ago.
Another major headwind has been the declining share of top IT firms The contribution of India's top six IT firms to overall IT exports has steadily declined, down from 47 percent in FY2012 to around 41 percent today. “Mid-tier IT companies have grown faster as deal sizes have broken into smaller chunks, creating a level playing field,” he added.
On the other hand, global IT services majors like Accenture, Capgemini, and IBM have expanded their operations in India. “The labour cost arbitrage that Indian IT companies relied on is no longer unique, as global players have scaled their presence in India,” he said.
The rise of Global Capability Centers (GCCs) has eaten into market share. “In FY2024, GCC revenues in India grew by 40 percent, compared to just around 5 percent growth for large-cap IT companies,” he said.
Order book activity also continues to be a concerns going ahead. “In Q2 FY25, Indian IT companies saw significantly weaker order activity, unlike global IT firms like Accenture, whose managed services order book remained robust,” he added.
Jain noted that without significant large deals, growth will depend on a revival in discretionary spending, which remains uncertain due to macroeconomic factors like interest rates and inflation.
Valuations in the IT sector, according to Jain, is adding to concerns. “Nifty IT is trading at 28 times earnings, compared to a six-year average of 23x,” he said adding that compared to global peers like Microsoft and NVIDIA, Indian IT companies like Infosys and TCS are trading at a premium despite slower dollar revenue growth.
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