How Will IT Services Fare in the Coming US Recession
Most commentators put a high probability on the US going into a recession. What began with a problem of imprudent housing loans in the US has snow balled into a crisis for the Financial Services industry and an almost certain slowdown in consumer spending. How this impacts the Indian IT Services industry requires some analysis.
The last US recession in 2001-02 was triggered by the Tech meltdown. Most IT Services companies went into the recession with a couple of slow quarters. Budget cuts at large accounts ate into the fundamental growth in the industry for a couple of quarters. But very soon, the recession started working in favour of the industry as more companies, facing weak earnings, chose to jump on the offshore outsourcing bandwagon. Soon it was back to double digit quarter on quarter growth.
Is this time going to be the same? I think there are some differences between this recession and the last one which bear examination.
First, the industry in the eye of the storm this time is the Financial Services industry. Most Indian services companies get 30 to 40% of their revenue from the Financial Services industry. The Financials also went through a slowdown in 2001, but the current recession could be a lot worse as far as this industry is concerned.
Second, the numbers are much larger now. The size of the industry at around $20B is now four to five times as large as it was in the last recession. There is a distinct possibility that the contraction due to budget cuts in large accounts may eat away all the growth from new accounts and more. There is also the matter that growth from new accounts, at least in the US, may not be as strong since there are very few companies with large IT budgets who don’t already have offshore programs.
Third, the decline of the dollar makes offshore outsourcing a little less attractive. Sure, the labour arbitrage is still high enough, and this is probably going to hurt margins more than growth, but every bit counts when you are facing a slow down.
The only silver lining, I feel, is Europe. From whatever I hear, Europe is showing strong growth for everyone in the business. The inclination to outsource is higher than ever before. It is possible that Europe may escape a full-blown recession although it will see some impact to GDP growth on account of the US recession. And lastly, the Euro is strong and the arbitrage is very attractive.
How these effects balance out, I do not know. But there will be strong headwinds ahead, for sure.
[Update: Kris Gopalakrishnan, CEO of Infosys, speaking at a conference said that so far the impact of the US slowdown is muted. The story is here . That is good news, however, we should not assume that this is how it will pan out over the duration of the recession for other companies.]