Is India's star finally dimming?

INDIA--Having enjoyed strong growth over the past few years, India's IT industry--spurred primarily by the bustling services and software markets--now faces the danger of slowing to a halt if the country does not resolve challenges brought about by an appreciating currency, severe manpower crunch, upcoming taxes and visa restrictions.

Just over a month after India's finance minister unveiled the annual budget, Kiran Karnik, president of the country's National Association of Software and Service Companies (Nasscom)--the premier trade body of the country's IT software and services industry--resigned from his post.

The budget introduced a fresh set of deterrents such as minimum alternative tax (MAT), service tax on lease rentals and "fringe benefit tax" on ESOPs (employee stock ownership plan), adding to the industry's existing list of woes that include rising costs, manpower crunch and H1-B visa restrictions, limiting the number of foreign IT professionals U.S. companies can hire.

With the announcement of Karnik's resignation last month, rumors swirled that the outgoing Nasscom president was under pressure to quit because he was unable to champion the tech industry's cause. He is expected to remain in the association for another five to seven months before his successor assumes the role, after which Karnik will take on an advisory role.

Just back from the United State where to sort out H1-B visa-related issues, Karnik told ZDNet Asia that his resignation has more to do with his age--he just turned 60--than the rumors.

However, he acknowledged that this year's budget was "bad" for his industry.

Ashish Gupta, COO and country head, Evalueserve, a leading knowledge process outsourcing (KPO) outfit, said: "Things are not hunky-dory any more. The appreciating rupee and taxes have certainly impacted the cost position of companies."

Taxing times
The Indian IT and ITES (IT-enabled services) industry had been granted a tax holiday--where they pay little or no taxes--until Mar. 31, 2009, giving it a significant cost advantage. The local industry was hoping that this timeline would be extended, but it had hoped in vain.

Karnik said: "Taxing the industry is a detrimental move. Some business may move to locations such as China, Hungary, Vietnam, Romania and the Philippines."

To make matters worse, the Rupee has appreciated by around 10 percent in the last few weeks, taking it to a nine-year high at around 40 rupee to a dollar.

While most Indian IT companies claim that forward trading has helped them cut losses, analysts point out that margins have already begun to take a hit. The profit margins of Tata Consultancy Services (TCS), for example, stood at 25.3 percent six years ago in comparison to 22.3 percent in its latest fiscal report. Infosys' profit margin had also gone down from 31 percent to 27.7 percent over the last six years, while Wipro's declined from 25.7 percent to 19.4 percent over the same period.

"Forward trading can protect companies from a strengthening currency only to a certain extent," explained Rachna Nath, executive director at consulting firm PricewaterhouseCoopers (PWC) India.

A practice commonly used in the commodity, foreign exchange or stock markets, forward trading refer to transactions where both parties agree to a delivery or settlement at a pre-agreed time in the future.

Ashish Basil, an executive for transaction advisory services at Ernst & Young India, concurred: "I see an immediate impact of the Rupee appreciation on the bottom line."

According to Karnik, the biggest challenge India's IT industry currently faces is the H1-B visa restriction imposed by the United States. "While the big companies [in India] have a bank of employees with H1-B visas, smaller firms in both India and the United States are suffering," he noted. However, Karnik expressed optimism that the 65,000 cap on H1-B visas will be lifted soon.

Tussle for talent
Meanwhile, most Indian IT companies are on a recruitment overdrive. For instance, TCS plans to hire 32,000 employees this year, while Infosys intends to hire some 24,500 and Wipro around 14,000 people.

According to a Forrester Research report released earlier this month, over 300 North American and European companies have set up their own offshore centers in India over the last two years to lower costs in product development and backoffice operations. But, the reported noted, more than 60 percent of these companies were now struggling to cope "due to spiraling costs, skyrocketing attrition, and lack of integration and management support". In fact, Forrester Research added that a number of early entrants to the market have since sold their centers.

To reduce costs, many companies are also setting up centers in India's smaller cities. For instance, a leading BPO service provider FirstSource, opened five new facilities in cities such as Hubli, Vishakapatnam, Cochin and Pondicherry.

However, PWC's Nath pointed out that this strategy too does not always help because poor infrastructure, scarcity of talent and poor connectivity--via air and road--are bigger obstacles in smaller towns. "People from large cities seldom want to move there for work," she added.

Ernst & Young's Basil said: "For many companies, meeting their minimum recruitment target has now become a challenge."

While India has a large pool of young people, where 75 percent of the country's population is below the age of 25, there is growing scarcity of employable manpower. This has led to stupendous rise in salaries.

"In the services industry, growth is dependent on manpower," said Basil. "When you can't find talent, growth is bound to slow down."

Today, IT and ITES companies are not just competing amongst themselves in their bid to attract talent, they also face increasing competition from India's sunrise industries such as retail, financial services and aviation.

Nasscom's Karnik said: "We have been working assiduously on the manpower issue. Companies have increased their emphasis on training and process orientation and are also assisting academia with inputs on curriculum." However, he is expecting India's IT growth to slow down in another three to four years.

While opportunities before the industry are huge, it needs to overcome the roadblocks to keep up the growth momentum.

"Innovation is the only way out," Nath concluded.

Swati Prasad is a freelance IT writer based in India.