Indian IT services sector is likely to see minimal revenue growth in 2020 amid the coronavirus pandemic, says Fitch Ratings.
Most customers will be cautious on IT spend as they focus on digital transformation and minimise IT spend on legacy services.
“Still, we expect high single-digit industry revenue growth in 2021-2022 on higher demand for digital transformation. We expect the Indian IT services industry to continue to take advantage of its low-cost operations and maintain its strong foothold in the global IT sector,” Keith Poon, Fitch Ratings, said.
The pandemic-related impact is likely to be only moderate and short term, as customers focus on transforming their businesses digitally, moving services and work platforms online, and minimise spending on legacy services.
Most companies have reported deal wins that should support growth, despite the revenue decline in 2Q20.
Mphasis had record-high deal wins of $259 million in 2Q20, of which 79 percent was related to new generation and digital businesses.
There is minimal impact on service delivery, as Indian IT services companies have adopted work-from-home (WFH) practices due to country lockdowns.
Indian industry will continue to take advantage of its low-cost operations and maintain its strong foothold in the global IT sector. The industry will continue to remain export-driven as it mainly serves US and Europe-based clients.
Fitch forecasts the industry’s revenue to rise by a high single-digit percentage during 2021-2022, after a relatively flat year in 2020. The industry has grown at a CAGR of 8 percent during 2014-2019, based on Fitch’s estimates.
Profitability, as measured by EBITDA margins, is likely to remain stable. Strong demand for the services, Indian rupee depreciation and cost-control measures, such as salary freezes during downturns, support the stable profitability.
Fitch forecasts the industry’s revenue will rise by a high single-digit percentage in 2021-2022, due to the increasing demand for digital transformation. We believe the pandemic-related revenue decline is only short term. The industry’s total revenue declined by 6 percent qoq in 2Q20, according to the National Association of Software and Service Companies (NASSCOM), as project delivery was affected by lockdowns and demand declined amid business disruption.
For example, sectors such as aviation and hospitality have suffered severe downturns and have sharply cut their IT spending.
Digital transformation of customers will drive higher demand for IT services in the medium term. In the new business environment, end-customers and employees stay at home more frequently due to social distancing and precautionary measures.
Companies are likely to accelerate their efforts in offering cloud-based online services and online working platforms to keep their businesses afloat. Research company Gartner forecasts the Indian IT services market revenue will expand by a CAGR of 10 percent and reach USD350 billion in 2025.
Fitch believes that IT services companies, those who focus on digital businesses, such as automation software and cloud-based service delivery, are likely to perform better than those with a focus on business process management (BPM) and legacy application and infrastructure services.
Infosys, the second-largest Indian IT services firm, recorded 2 percent yoy constant currency revenue growth in 2Q20, while its digital revenue rose by 26 percent over the same period, contributing 45 percent of total revenue.
Disruptive technologies such as big data analytics, cloud computing and machine learning will become new growth drivers for the IT services industry. Indian IT services companies will benefit by assisting their customers in achieving automation, adopting cloud services, migrating products and processes online and enhancing customer experiences on digital channels.
Fitch expects the growth of IT spending in the banking, financial services and insurance (BFSI) vertical to recover, and that will spur the revenue growth of Indian IT services firms in the medium term. Banks in the US and Europe have seen a rising adoption in the use of digital channels in areas such as retail banking and wealth management amid the pandemic.
For instance, 62 percent of primary checking account openings in the US were submitted through digital channels (online or mobile) in 1H20, compared with 52 percent in 2H19, according to Cornerstone Advisors’ data.
Banks have been aggressive in expanding their digital channels. Credit Suisse is planning to launch a digital banking app to offer free foreign transactions and wealth management tools. JPMorgan Chase is launching its digital bank in the UK in 2021.
In the non-bank area, companies with digital business models outperform. PayPal Holdings, expects to add 70 million net new accounts in 2020, nearly double the rate of 2019. The trend of banks’ digital transformation will continue, as 24 percent of customers plan to use branches less or stop visiting branches when the crisis is over, based on a Boston Consultancy Group survey.
Infosys announced five large deals in BFSI in the first quarter of the financial year ending March 2021 and its largest-ever deal with Vanguard Group in July.
Indian IT services companies have adopted WFH practices. WFH ratios were particularly high in India because the country imposed strict lockdowns for an extended period. Over 90 percent of employees of these companies are working from home. WFH will not affect revenue growth as most companies have reported seamless transition to WFH.
Tata Consultancy Services (TCS) has indicated that only 25 percent of their employees will need to work from the office premises by 2025, as customers are comfortable with this model.
Infosys believes 33 percent to 50 percent of their employees will WFH on a permanent basis. WFH measures may imply more offshoring in the longer term, as they give strong evidence that projects can be delivered remotely. The billing rates for onsite work are 3.0x-4.0x higher than that for offshore work. As a result, a higher proportion of offshore projects may affect the industry’s revenue growth rate.