India's IT growth trails global clients amid shift in tech spending; experts urge caution

The divergence in revenue growth also signals that the slowdown in the IT sector is not entirely because clients are holding back their usual IT spending. The five largest IT services companies account for 28% of the country’s overall tech sector and the slowdown in their revenue growth might have a cascading effect on their smaller rival companies.

“Our lack of enthusiasm on IT Services continues to be premised on an unconvincing revenue growth trajectory ahead. Prior to CY23, IT Services companies exhibited strong correlation with the S&P 500 and Stoxx Euro 100’s revenue (a cogent proxy of IT companies’ client base)," ICICI Securities analysts Ruchi Mukhija, Aditi Patil and Seema Nayak said in a note dated 28 November. “... this correlation has weakened since CY23, with top 5 IT Services companies’ revenue growing at ~1-2% vs. ~3-5%+ revenue growth for S&P 500 and Stoxx 600."

The S&P 500 is a basket of the 500 largest companies trading in the US, whereas the Stoxx Europe 600 index includes the largest companies across 17 countries of the European Union.

Traditionally, growth at large companies was a proxy for the prospects of the largest IT services companies. It meant they had more money to invest in tech projects, resulting in faster growth for their IT vendors, which ended up getting more business. However, automation has done away with that notion, according to analysts. The decoupling in growth makes it tougher to gauge the direction in which the sector is headed.

A changed playbook

The rise in the usage of automation tools, the shift of IT spends to product-based and AI infrastructure companies, and investments in in-house tech centres have contributed to this decoupling.

Automation has changed the playbook for the country’s IT sector. According to a Mint report on 21 July, IT deals get priced on outcome rather than on the number of people employed in those projects. Mint reported last month that higher revenue would not correspond to a proportionate rise in headcount as automation reduced the need to deploy excess people in projects.

Revenue at the top five Indian IT services companies including Tata Consultancy Services Ltd, Infosys Ltd and HCL Technologies Ltd also grew at a slower pace than the Forbes Global 2000 companies including JPMorgan Chase & Co, Microsoft Corporation, and Saudi Aramco from January 2023. While quarterly growth at the tier-1 IT outsourcing companies slowed to less than 5%, that of the G2000 companies started to inch towards the 5% mark, according to a Nomura note dated 27 November.

The steepest revenue growth divergence was in the technology sector. The S&P 500’s technology revenue grew upwards of 15%, whereas the tech revenue of IT services companies’ grew at about 1%. The ICICI analysts attributed this to the technology sector being an early adopter of GenAI and leveraging AI technology to optimise costs better, thus reducing spend on IT services.

The Big Five get 8-16% of their revenue from tech companies including Microsoft and Apple. Of the top IT service providers, Wipro has the highest exposure to these companies. For now, analysts attribute the divergence in overall revenue growth to three factors including automation tools and client companies spending on global capacity centres (GCCs).

Spending shifts

“IT Services revenue growth vs. S&P 500 and Stoxx 600 was materially higher in the past, but this growth gap has reversed, likely due to headwinds from – 1) shift of IT spends to GCCs; 2) shift of spends to AI infrastructure and product companies; and 3) deflationary impact from GenAI-driven productivity," the ICICI analysts said.

Nomura added that IT outsourcers are getting hurt by automation tools as fewer people are billed to service a project.

“The initial deflation due to AI is hurting net revenue growth (for homegrown IT services companies) in an uncertain macroeconomic environment, making clients focused on cost reductions and delaying discretionary spends," the Nomura analysts said.

The country’s Big Five have been grappling with a tough demand environment as growth has slowed down compared with the FY23 period when the Covid outbreak prompted companies to shift their operations online and give more work to IT outsourcers.

TCS, Infosys and HCLTech ended last year with $30.18 billion, $19.28 billion and $13.84 billion in revenue, growing 3.78%, 3.85%, and 4.3%, respectively. On the other hand, Wipro Ltd reported revenue declined 2.72% to $10.5 billion and Tech Mahindra Ltd’s revenue fell 0.21% to $6.26 billion. In contrast, each of these companies grew by 7-12% in FY23.

Experts said the divergence was the result of a change in spending patterns of the large multinationals.

“The S&P 500 companies have shifted their budgets toward AI infrastructure, data modernization and automation. These are heavy capex and cloud commitments, not traditional IT outsourcing deals," said Phil Fersht, chief executive of HFS Research. “Big enterprises are growing revenue on the back of AI-fuelled productivity, but they are not expanding run-the-business IT contracts the way they did for 20 years."

AI productivity

“The growth (for the IT services companies) did not show up in the tech services market as it was stolen or shifted by two significant factors including insourcing, where companies started doing the work themselves," said Peter Bendor-Samuel, founder of Everest Group. “The second factor is AI where firms are using AI themselves and not using third parties. Another factor is in the compression of revenues as AI creates more productivity and several of the tech services firms are already delivering work at 30%+ productivity."

TCS, the country’s largest IT services company, outlined tougher days in the short term.

“IT services spend is steady with no significant change expected in the near term. Lingering uncertainties in the broader economic environment continue to remain a key challenge. Companies are keeping tight control over their discretionary budgets," K Krithivasan, chief executive of TCS, told analysts on 9 October.

Still, the company expects its overseas revenue, which makes up more than 90% of the total, to be better than in the previous fiscal. Nomura analysts voiced a similar opinion.

“A faster rate-cutting cycle and an improvement in the macroeconomic situation due to tariff issues getting settled can be a tailwind for growth," Nomura analysts Abhishek Bhandari and Karan Nain said in a note dated 27 November.

A cut in lending rates reduces borrowing costs for companies and allows them to invest more in non-essential tech projects, which are a key revenue driver for Indian IT.