Why Indian IT firms dread US economic uncertainty

Earlier this month, the US delivered a series of disappointing macroeconomic numbers, raising concerns about a possible recession there. The news decimated stock markets globally, including India’s, on 5 August. But India's benchmark information technology (IT) stock index, led by the top five companies in the sector, crashed hardest. That's because their financial health is tied closely to the US economy. Each of the top five firms—Tata Consultancy Services (TCS), Infosys, Wipro, HCLTech and Tech Mahindra—earn more than half their revenues from the Americas, mainly the US.

The US data released this month indicated trouble. First, numbers from the Institute of Supply Management showed manufacturing activity in the US fell to an eight-month low. Then, the Labor Department said the US unemployment rate had increased for four straight months to 4.3% in July. A cut in interest rates could help, but it's not clear if the US central bank will pursue that path when it meets next month, given the inflationary pressures. In such conditions, businesses tend to cut discretionary spending such as digital transformation projects, which, in turn, impacts IT services firms' growth.

Indian IT services companies have gradually been reducing their dependence on the US. For three of the top five companies, the revenue share of Americas shrank in the June quarter. Yet, the US cannot be ignored. It accounts for 35.7% of the global information and communications technology (ICT) market, and is nearly thrice the size of the European Union, according to an analysis by Statista.

Granular recovery

While macroeconomy matters, specific sectors and sub-segments are also important for IT services companies. Banking is a case in point. When Silicon Valley Bank’s collapse in 2023 triggered concerns about a broader banking crisis, JP Morgan pointed out that TCS and Infosys had the highest exposure to US regional banks. 

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That segment has since recovered, and some banking sub-segments have recovered enough to increase their tech spending. Infosys chief financial officer Jayesh Sanghrajka told analysts last month that the company saw a recovery in areas such as mortgages, capital markets and card payments. Infosys reported its first sequential growth in this segment in six quarters.

However, for the top five companies, the share of banking and finance has shrunk year-on-year. It's expected to improve as spending picks up, which is likely to happen in phases. TCS chief executive officer K Krithivasan sees increased spending on security, risk and regulations in the near term, and on integrating cloud and artificial intelligence (AI) in the longer term.

AI pipeline

Ever since the launch of ChatGPT in 2022, the commentary on AI has been overwhelmingly positive in the US. Venture capitalists (VCs) have continued to pour billions of dollars into AI startups, more than doubling their investments year-on-year to $24.1 billion in the June quarter. Microsoft's investment in OpenAI is estimated to be about $13 billion.

Also read: Gen AI pushes global firms to pour money into hardware upgrades

However, there have been questions of late about returns on these investments, and speculation that AI might turn out to be another bubble. How AI evolves is important for Indian IT firms, which have invested time and effort in upskilling employees to ride on the wave. One reason why returns on AI are not evident yet could be that it's still being deployed. Krithivasan told analysts that “organisations were taking a calibrated approach to measure the risk potential and organizational impact”. TCS currently has AI and GenAI deals worth $1.5 billion in the pipeline.

Talent pool

All IT companies have been training employees in AI, partly to prepare them for the future of software development. But there’s one more reason: at a time when demand for their services has slowed down, the companies could use existing resources instead of hiring fresh talent.

In FY24, the total headcount of the top five firms shrank by about 69,000. Attrition rates have been dropping consistently as employment opportunities have dried up. It's a key reason why the IT sector is looking for sign of a recovery in the US economy. During every election season, anti-outsourcing rhetoric increases in the US. Indian IT companies have increased their local hiring over the years (an estimated 37,000 people between 2017 and 2021). Yet, when the economy is not doing well, there are concerns that the rhetoric could go up a few notches.

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