The Indian IT services industry is expected to have short term adverse impact due to coronavirus outbreak, according to ICRA.
The Indian IT services sector is expected to grow at -3 percent – Nil in FY2021 versus ICRA’s earlier expectation of 6-8 percent.
With the slowdown in growth during the first half of FY2021, the margins will also be negatively impacted before a likely recovery in FY2022.
The global spread of the coronavirus has resulted in simultaneous supply and demand shocks. IT Services companies have managed to overcome supply led challenges via uninterrupted delivery of IT services, through work from home model however, the challenges on the demand front continue to persist.
The US and the Eurozone which generates more than 80 percent of IT Services export revenues will see their GDP contract by -8 percent and 10.2 percent (Source: IMF, June 2020 Update) respectively in CY2020.
As growth slows down during the first half of FY2021, the margins will be impacted though ICRA expect them to gradually recover in FY2022. The margins for the Indian IT Services are already facing challenging operating environment characterised by continued pressure on commoditised IT services, wage inflation, higher onsite costs necessitated by visa curbs as well as lower discretionary spend by corporate.
ICRA expects large size companies with diversified presence across sectors to manage such headwinds better compared to mid-size companies which have moderately high proportion of revenues coming from few sectors coupled with vendor consolidation exercise during Covid-19 benefitting such large size players.
With aggregate operating margins of ICRA sample set at 22.3 percent in FY2020 coupled with moderate capex (organic as well as inorganic) and working capital requirements, the free cash flows have remained robust historically.
Despite flattish growth and margins pressure over the medium term, these factors are unlikely to impact the free cash flow generation ability of Indian IT Services companies though there could be moderation in the quantum of such cash flows, ICRA said.
Gaurav Jain, vice president at ICRA, said: “The global spread of the coronavirus has resulted in simultaneous supply and demand shocks. IT Services companies have managed to overcome supply led challenges through uninterrupted delivery of IT services, through work from home model however, the challenges on the demand front continue to persist.”
The IT Services companies achieved 90-95 percent target of work from home for majority of the IT Services players by April with integration for Application, IMS and Analytics. The BFSI vertical was impacted due to required modification in confidentiality agreements with clients while Business Process Outsourcing (BPO) was impacted due to infrastructure constraints.
On the supply side, Indian IT services will continue to face issues such as travel restrictions to developed countries. At the initial stages of projects, movement of labour at client’s site is essential while later the same can be managed remotely. New projects to be commissioned will be delayed by minimum of 3-6 months while projects in pipeline will also face delays.
The temporary suspension of issuance of fresh H-1B visas and L-1 visas (inter-company transfer) till December 2020 in view of the impact of Covid-19 pandemic on US economy and employment will mildly impact Indian IT Services sector considering their high dependence on such visas though pandemic has anyways led to reduced travel requirements for the foreseeable future.
On the demand side, developed economies which contribute to majority of the revenues will see delayed off-take of scheduled new projects, reduced discretionary spend as well as overall lower spend owing to sluggish economic growth.
The BFSI vertical (30 percent of sector revenues) which is already seeing weakness across US and Europe will be further impacted primarily owing to medium term impact of coronavirus on economic growth, low interest rate regime, lower credit off-take and other banking services.
Other key sectors such as Oil and gas will be impacted because of record low crude oil prices leading to reduced discretionary spends by such companies.
Manufacturing sector which has been one of the key growth drivers is also expected to be adversely hit due to overall lower consumption.
Travel, Airlines and Hospitality followed by Retail will be impacted the most as consumers will restrict outdoor activities to essentials in the foreseeable future. Overall, ICRA expects the pace of new contract award to fall by at least 700-900 bps in CY2021.