The information technology (IT) services sector will sustain double-digit revenue growth this fiscal, at 12-13%, driven by digitalisation, strong demand for new-age technologies¹, and depreciation in the rupee.

This would mean a moderation from ~19% growth last fiscal — the highest in the past eight years — given an expected tightening of IT expenditure by corporates amid the inflationary headwinds in the United States (US) and European Union (EU), which together contribute almost 85% to the sector’s revenue.

However, revenue growth has support from the shift in various industries globally towards automation, digitalisation and digital transformation services in the wake of the Covid-19 pandemic. Also, the higher growth last fiscal had come on the back of a modest uptick of 6% in fiscal 2021, which was hit by the first wave of the pandemic.

Operating profitability will also remain healthy, but could fall back a tad to the pre-pandemic low of 22-23%, compared with ~24% last fiscal, due to rising employee cost and increasing travel expenses.

Credit quality of the sector, however, will remain ‘positive’, supported by continued healthy cash generation, strong balance sheets, and robust liquid surpluses.

A CRISIL Ratings study of the top 19 firms, accounting for ~70% of the ~Rs 9 lakh crore Indian IT services sector last fiscal, indicates as much.

Says Aditya Jhaver, Director, CRISIL Ratings, “With spending on cloud infrastructure expected to grow 1.5 times in the next three years and increasing adoption of new-age technologies such as cybersecurity and Internet of Things, the digital share of revenue of Indian IT service players may cross 50% over the next 1-2 years (~47% in fiscal 2022). That said, rising inflationary headwinds in key client countries may spur corporates to curb discretionary spending and moderate revenue growth over the medium term.”

Almost 75% of revenue of the Indian IT services sector comes from the BFSI (banking, financial services and insurance; revenue share of 30%), retail, manufacturing, and telecom (~15% each) verticals. Revenue growth from BFSI will remain healthy at 15-17% this fiscal, versus 18% last fiscal, despite the increasing interest rates, backed by rising digital transactions, predictive analytics, cloud and data security.

However, corporates in the retail, manufacturing and telecom verticals are expected to tighten IT spending amid the highest inflation rates in the past two decades in the key US and EU markets. Hence, revenue growth from these verticals is seen moderating to 11-13% this fiscal from 15-17% last fiscal.

Says Tanvi Shah, Associate Director, CRISIL Ratings, “The operating profitability will moderate to the pre-pandemic lows of 22-23% given the rising employee costs, both to retain talent amid high attrition and maintain a larger employee base. In fact, net employee addition by Tier 1 players² was at an all-time high of 2.7 lakh last fiscal amid high attrition, which peaked to ~21% in the fourth quarter of the fiscal from ~10% a year ago. Besides, revival in international travel and higher discretionary costs will also weigh on operating profitability.”

However, margins for the players will be supported by premium pricing as well as effective cost levers through maintaining a healthy off/on-shore employee mix and reducing sub-contracting amidst rising visa approvals with roll-back of protectionist policies in key service regions.

Credit quality of players in the IT services space should remain ‘positive’, supported by healthy cash generation, strong balance sheets, and sizeable liquid surpluses (~Rs 60,000 crore at March 31, 2022). The acquisitive nature of players is expected to sustain, mainly for enhancing digital share of revenues, but this is unlikely to dent their credit profiles.

All said, any further surge in inflationary headwinds leading to deferral of discretionary IT spending by corporates will bear watching.

¹New-age technologies include artificial intelligence, cloud computing, internet of things, etc. which fundamentally changes the way a business operates or delivers value to its customers.
²Players with revenues more than Rs 40,000 crore