Can Indian firms combat slowdown this time?

Despite the decoupling theory, we believe that the economic slowdown in the US is already showing its impact on the Indian market, in particular the Indian IT industry.

The Indian rupee has been strengthening against the US dollar for over a year now, causing more worries for Indian exporters.

In case of severe recession in the US, the rupee may appreciate further against the dollar. This is likely to have an immediate effect on the Indian IT-Enabled Services (IT-ITeS) industry, where the US accounts for the largest share at over 60 per cent (according to Nasscom) of the Indian software and outsourcing market.

This slowdown is expected to have an adverse impact on the smaller IT-ITeS firms, which may lead to increased consolidation in the small and medium-sized industry segment.

A majority of the revenues of all big IT firms in India comes from the BFSI segment, which is undergoing the subprime mortgage losses resulting in recession in the industry.

The rupee appreciation is doing no good either. Companies in India are looking at rationalization of the staff to effect better cost control to combat declining margins.

Recent reports in the Indian media indicate that two of the top IT firms have already initiated steps in this direction. Other companies are expected to follow suite.

The impact of the slowdown on the Indian market has largely been offset by the cost cutting advantages offered by the Indian economy. This would mean more and more work being outsourced to India.

SMEs in the US are under severe pressure to increase profitability and business margins. This may turn out to be a blessing in disguise for Indian firms as these SMEs are likely to outsource work to countries like India, which offer a considerable cost advantage.

By March 2008, India had received SME outsourcing deals worth $7 billion from the US as against $6.2 billion in the previous year. This is expected to reach $8 billion by March 2009 and $11 billion by March 2010. The total outsourcing from the US by that time is estimated to be $54 billion.

The recession has also helped the bigwigs of the Indian IT industry to test waters beyond the US territory, and also to look into other industries and verticals for their business needs.

According to the Forrester Group, the US companies are now holding back their IT budgets to cut expenses especially on new project developments as they can do little to reduce the expenses on ongoing maintenance work.

However, they may increasingly start looking at offshoring the same to offset the cost pressure especially in case the present recession settles to become a mild one.

Arguably, this time India Inc is better prepared for the slowdown compared to the dotcom burst. The global economy today is fundamentally different than it was 7–8 years ago during the last US recession in 2001.

The earlier recession had triggered a very significant opportunity for Indian companies, and the explosive growth in outsourcing in the ITeS sector.

US companies has began to seek opportunities to cut cost across the board and started establishing relationships with the software providers.

While the IT sector found it relatively easy to move from pure IT relationships to much broader spectrum relationships in terms of outsourcing and it was an opportunity that India gained because of the business cycle downturn in the US.

The recession of 2001 was a combination of rapidly increasing stock prices, individual speculation in stocks, and widely available venture capital.

The dotcom bubble crash wiped out $5 trillion in market value of technology companies from March 2000 to October 2002. Most of the dotcom companies were clients of the Indian IT firms. This in turn resulted in a crash in the Indian IT sector, which is looking at several measures to minimize the impact of the current expected recession.

They are spreading their client base to Europe, Middle-east, Canada, Africa and other countries in order to diversify their risks. They are also servicing a more diverse array of sectors/industries.

In addition, Indian IT companies are acquiring firms in different countries to spread their base and also use the local expertise in their favor. This trend has shown an increase in the kind of services being outsourced.

Indian companies are looking at Green IT as the way forward. An increasing degree of economic responsibility, rising cost of power, shortage of power, high backup capex are among the key drivers for the green initiative among Indian enterprises.

Notably, a recent Dataquest article reveals that 55 per cent of the top 60 CIOs in India have energy efficiency as part of their top three KRAs for 2008–09.

(The author is partner, Transaction Advisory Services, Ernst and Young)