news analysis When the United States sneezes, the world catches a cold--so the adage goes. That could prove particularly true for India's IT and IT-enabled services (IT-ITES) industry, where the United States accounts for the largest share--at over 50 percent--of the Indian software and outsourcing market.
"The U.S. slowdown will impact the smaller IT-ITES firms more," Hari Rajagopalachari, executive director at PricewaterhouseCoopers India, told ZDNet Asia in an e-mail interview. In fact, he added, it may lead to increased consolidation in the small and midsize industry segment.
According to Milan Sheth, Ernst & Young India's partner of business advisory services and leader of technology and telecom verticals, the economic slowdown will most affect midsize IT-ITES companies.
"Most small firms have very strong niches. It's the midsize firms that will be badly hit in the event of a portfolio rationalization by the American clients," Sheth told ZDNetAsia in a phone interview.
The economic slowdown in the United States has already had some impact on the Indian market. The rupee has been strengthening against the dollar for over a year now, causing worries for Indian exporters.
The Indian stock markets also crashed due to the downturn, with the BSE Sensex dipping by nearly 13 per cent in just two trading sessions in January this year. It bounced back after the U.S. Federal Reserve cut interest rates. The BSE Sensex, or Bombay Stock Exchange Sensitive Index, comprises 30 of BSE's largest and most actively traded stocks.
"The U.S. slowdown is a long and protracted one," Rajagopalachari said. He explained that the U.S. slowdown is due to structural readjustments in the country, while the global economic scenario is caused by changing fundamentals in the currency, energy and financial markets.
"The implications for all of India's externally linked sectors are significant," he said. "The strongest and most immediate impact will be on the IT-ITES sector."
The weak will fall
Sheth noted that while the budgets of the U.S.-based companies will undoubtedly be cut, the services of Indian companies that are adding value will be retained.
"Those companies that haven't performed may lose out," he said. "For instance, if an American telecom company today has 18 vendors, out of which 12 are in India, it may want to reduce that number to 14 or 16. So, the less efficient ones may be weeded out first."
And while the economic slowdown implies added pressure to cut costs through further offshoring, which brings good news for Indian service providers, this sweetener would take some time to materialize.
Rajagopalachari said: "In the long term, low-cost offshoring trend will increase. But in the short term, between 12 and 18 months, there will be a demand contraction due to management changes and a paralysis in decision-making in the U.S. corporate sector."
During a recent media briefing, Kemal Dervis, administrator at the United Nations Development Program (UNDP), said the U.S. slowdown might make it difficult for India to sustain its economic growth rate of 8 percent.
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Rajagopalachari concurred: "The U.S. economic crisis is structural and hence long-term. It is not a cyclical phenomenon alone. India will be impacted significantly," he said. "About 50 percent of India's economic growth is structural and the rest is affected by cyclical factors."
"Over the next three to five years, it is difficult to see Indian growth rates outside the 5- to 8 percent range. The U.S. contraction in consumption will hit exports across sectors, not just in the IT-ITES sectors," he said.
India's way out of the downturn cycle, Rajagopalachari said, is to step up domestic consumption in the face of rising inflation.
According to Sheth, the challenge Indian companies face is to demonstrate their ability to value-add.
Over the last 12 months, Indian companies have been diversifying their risks by increasing their focus on the non-US markets, such as Europe.
However, Rajagopalachari said, given the preponderance of U.S. revenues in the portfolios of India's IT-ITES sector, the positive impact on revenues and margins as a result of revenue diversification away from the US markets, is "marginal".
Indian IT-ITES companies have also undertaken labor-cost rationalization by getting rid of non-performing workforce and by tightening recruitment policies. There has been a sharper focus on increasing offshore leverage in projects to improve profitability.
Companies have also reduced the average age of the workforce in order to reduce cost and improve overall profitability. Sheth said: "Companies may not be adding the kind of people that they were last year, but they are definitely getting better yield from existing employees."
There is, however, silver lining amid the gloom. For instance, the pressure on American companies to increase offshoring activities in order to combat cost pressure, will increase in due course.
Reports also highlight that despite the U.S. slowdown, the number of acquisitions by Indian IT-ITES companies in the United States during the first two months of 2008, increased by nearly 75 percent.
Sheth added: "One must not forget that India's domestic demand is booming."
In addition, the slowdown has accelerated the desire of India-born professionals based in the United States to return to their home soil. While such IT professionals previously returned in hopes of being part of the India growth story, today, the sub-prime crisis, slowing economy and fear of layoffs in the United States are prompting these workers to look for opportunities in India.
As a result, India's talent pool is getting richer and it could only be a matter of time before the Indian IT-ITES industry overcomes the U.S. slowdown hiccup.
Swati Prasad is a freelance IT writer based in India.