Information technology (IT) analysts are largely a happy bunch. Their primary arguments for an overall rosy macro outlook include comments that there appear to be no headwinds seen on clients’ IT budgets because of the deal renewal cycles as well as the fact that digital spending is now becoming “non-discretionary". The latter supposedly means that IT departments at client firms that outsource to service providers have no choice but to spend large amounts on digital projects.

Early last year in this column, I predicted that IT services firms would have a good 2018, primarily because of large deals being recycled out into the market, and because of early “digital" efforts made by clients now moving into the mainstream. The first phenomenon is a cyclical one, and it appears as if the effect of the expansion caused by deal renewals will continue into 2019.

As the spending on digital goes from the ideation stage (where Indian IT services firms have a lacklustre presence) to the execution stage, which allows them to compete on a level playing field with others, Indian players are seen benefiting from clients’ budgets. The other macro shift that worked in favour of Indian service providers in 2018 was the fall in the value of the rupee vis-à-vis the dollar.

While the positive impacts are clear, each enterprise has had firm-specific factors affecting performance. And so, much of the commentary this quarter has started to focus on the relative differences among firms. Analysts seem to favour stocks such as Tata Consultancy Services Ltd, HCL Technologies Ltd and Infosys Ltd, while being lukewarm towards others.

There is also speculation about probable consolidation among mid-cap providers, especially where existing investors, such as private equity firms or large single investors, look to monetize their stake through exits and forced mergers. The promoter equity at these firms is now dwarfed by the private equity stake, and investors will have to look to moves by private equity firms as a leading indicator of stock price performance.

Last week, Mint carried an article about moves by Baring PE Asia, KKR and Café Coffee Day’s V.G. Siddhartha, which could massively impact at least a couple of mid-cap providers that are already billion-dollar revenue bracket firms.

The rest of the analysis seems to focus on the expected spending from the banking, financial services and insurance (BFSI) sector, the largest sector from a revenue perspective for almost all Indian IT services firms. This analysis focuses on two vectors.

The first vector is on the interplay between insourcing of work through the BFSI sector’s India-based in-house delivery centres and outsourcing of work to IT services firms.

The second vector is on the apparent spending pattern within BFSI, which is seeing cautious expansion into digital running alongside continued spending on older systems.

Such fine splitting of hairs while analysing recent results and near-term forecasts is but to be expected in a sector that has grown mature, and by some accounts, past its “use by" date. In my opinion, however, most analysts seem to have completely missed three elephants in the room.

The first elephant is the turmoil in the US equity markets, which indicates the end of a long expansion and the possible start of economic contraction in that market. This contraction is based on fears of a “bull in a China shop" (quite literally) attitude toward US trade with China, increasing rhetoric around US trade wars and slowing growth in both China and Europe.

After a decade of growth, many investors are worried that a contraction is near, and December’s jitters on the heels of a threatened fifth raise of interest rates by America’s Federal Reserve was only a preview. Markets in the US have calmed over the past few days and US stocks have seen a rebound, but only because another interest rate action by the Fed now seems less likely, after the Federal Reserve officials repeatedly assured investors that they were sensitive to concerns about the economy and would be flexible and patient with further interest rate hikes. However, many factors behind last year’s alarming and precipitous drop loom in the shadows.

IT analysts also seem blind to two other pachyderms: political upheaval in both the US and in the UK, still two of the largest markets for Indian IT. The first is the ongoing battle between US President Donald Trump and those who oppose his border wall proposal and the latter is the complete chaos on Brexit.

The US is now well into its longest government shutdown, with Trump and opposition Democrats casting blame for the deadlock on each other. Whoever is to blame, there is no doubt at all that the shutdown will exact a massive price on the US economy; the shutdown’s total costs will far outweigh the $5.7 billion for the wall that Trump and the Democrats are quarrelling about. According to Standard & Poor’s, the last time the US government shut down for 16 days in 2013, the economy took a $24 billion hit. This shutdown is 31 days old and counting.

Start to get very picky with your investments in Indian IT.

Siddharth Pai is founder of Siana Capital, a venture fund management company focused on tech.

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