IN OCTOBER, while announcing Wipro’s second-quarter results, CEO & MD Thierry Delaporte did not shy away from acknowledging the very preliminary but palpable footprint of economic headwinds in business conversations and — at times — in decisions. “In speaking to our clients every day, we have seen a change in the level of optimism as businesses around the world are dealing with inflationary pressures and geo-political turmoil, energy crisis and rising interest rates... There is, indeed, a certain level of uncertainty. Large technology companies are slowing down and it’s a reality,” he said.

Infosys goes a step further. “We are ready in this macro environment for all types of client work, whether it focuses on digital, growth or cost. We want to be careful that we are cognisant of what’s going on in the macro environment and make sure we go into this watchfully. We have a very strong set of capabilities in digital and Cloud. We also have capabilities in automation and are seeing traction in cost programmes. We want to make sure that both engines are made available to clients,” says CEO and MD Salil Parekh.

Discretionary spending in select sectors, including retail, high-tech, telecom and financial services, has been hit hard. These are transformation projects that aim at going digital, but only indirectly affect the company’s topline or bottomline — for instance, projects that improve stakeholder experience by leveraging artificial intelligence (AI) or machine learning (ML), says Nitin Bhatt, technology sector leader, EY. “We see more caution at the way clients are looking at services,” adds Parekh.

India’s $227 billion IT industry, which rode on the pandemic-led digitisation juggernaut, building on growth and adding market share, is bracing for a probable slowdown as major markets, including the U.S. and Europe, stare at a recession. The International Monetary Fund (IMF) projects growth in the U.S. to decline from 5.7% in 2021 to 1.6% in 2022 and 1.0% in 2023. For the Euro area, it estimates growth in the range of 3.1% in 2022 and 0.5% in 2023. In another report released in September, the World Bank said the world may be edging towards a global recession in 2023 as central banks hike interest rates in response to inflation. The IMF estimates global inflation to rise from 4.7% in 2021 to 8.8% in 2022.

The grim projections spell risks for the IT sector which gets more than 80% of its revenues from the U.S. and Europe. According to industry observers, the expected impact of a slowdown in the West is already reflecting in sectoral indices. The Nifty IT index, for instance, fell 24% in 2022 (till November 11) against a 4% rise in the broader Nifty (See: Of Losses & Gains).

Early Signs

The impact has not been across the board, but there are signs of initial slowdown. In Q2FY23, Wipro’s gross revenue, for instance, grew 14.6% year-on-year, slower than 17.9% in Q1. In constant currency terms, revenues grew 12.9% YoY in the July-September quarter, against 17.2% in the previous quarter. Infosys also saw a lower revenue growth at 18.8% in constant currency terms in Q2FY23, compared with 21.4% in Q1. The country’s largest IT services exporter Tata Consultancy Services’ (TCS) revenue growth also remained flat over the past two quarters — 15.4% in Q2FY23, almost similar to 15.5% in Q1.

Shiv Nadar-led HCL Technologies, however, has been an outlier. In Q2FY23, its revenues grew 15.8% YoY in constant currency terms, marginally higher than 15.6% in the previous quarter.

Treading with Caution

IT firms are taking a cautious approach as clients rework strategies to navigate potential risks from an emerging global economic slowdown. “Clients have become more cautious when committing to long-term investments. Many of them are working on plans for various economic scenarios for next year. We have also seen some sporadic instances of delayed decision making on new deals,” TCS CEO and MD Rajesh Gopinathan said while addressing the Q2FY23 analyst call. Wipro’s Delaporte, meanwhile, said clients are not yet talking about slashing technology budgets. “But, they are saying we don’t know. There is a level of uncertainty,” he cautioned.

Infosys’ Parekh categorises sectors that are feeling the heat of macro-instability. Besides pockets of retail, financial services, mortgages, clients in high-tech and telecom spaces are capping discretionary spends. “We want to be careful that we are cognisant of what’s going on with the macro environment and make sure we go into this watchfully,” says Parekh.

HCL Tech CEO and MD C. Vijayakumar echoes similar thoughts. “The macro uncertainty is weighing on clients, and they are prioritising areas where they need to spend. Accordingly, there could be projects where they are ramping down. It’s a constant trend that we see in such situations,” he says.

“Experimental projects that several companies had started, which includes focus on areas such as blockchain, cryptos, etc., may not get extended or is likely to see a pause,” adds Devroop Dhar, co-founder and MD, Primus Partners India a business and management consulting firm.

The Silver Lining

But then, every crisis brings along opportunities as well. While clients are likely to cut down on discretionary spends and restrict the flow of non-urgent projects, firms will sharpen their focus on programmes with emphasis on automation and cost optimisation.

“While digital continues to see strong growth, there has been an acceleration in the growth trajectory of our core services this quarter. This reflects an interest among clients towards cost optimisation programmes. We also see this in our large deals pipeline with strong focus on cost reduction, in addition to digital transformation,” says Infosys’ Parekh.

TCS’s cognitive automation software suite Ignio, for instance, signed up four new customers and three clients went live during Q2FY23. There is also a greater interest from clients in its ‘machine-first approach’ to transform their IT and business models.

“This approach entails embedding AI and ML deep within an enterprise to create leaner, more agile and resilient operations, which can flex up or down depending on the business environment, and whose efficiency gains can fund some of the front office transformation initiatives,” Gopinathan said during the analyst call. TCS claims several such wins during the July-September quarter. The IT major has partnered with Xerox to automate the US-based firm’s processing functions. “This has resulted in a positive impact on the cash flow, and significantly improved operational efficiency,” said Gopinathan.

Automation driven by AI and ML models are being used by clients as cost optimisation drivers, and a large portion of the recent large deal wins have focused on driving automation to optimise operating models, supply chains and reduce costs, adds EY’s Bhatt.

Digital transformation projects with emphasis on areas such as Cloud that enhances business operations will remain in favour, according to analysts. “The expectation is that while U.S. and European firms may tighten their IT budgets in response to recessionary trends, the focus on digital transformation and key services (Cloud, mobile and analytics) with short-term impact, will continue to remain robust,” says Pawan Kumar S., partner and leader, technology consulting, PwC India.

The Motif

Digital transformation journeys serve two objectives. One, they provide significant business benefits, and second, they help simplify the tech landscape and reduce operating costs, explains HCL’s Vijayakumar. “Depending on the nature of deals, we see continuing acceleration in the sweet spot that we are playing in, where digital transformation is delivering significant business outcomes, while also reducing operating costs,” says Vijayakumar, who claims the firm has won a mega deal in Q2FY23, which is expected to give the IT company an average contract value of $125 million per year from FY24.

“We know that technology has become the underlying success factor for any business, in good times and bad… regardless of what the problem is, technology is the solution,” Delaporte said during the analyst call.

Image : Photograph by Narendra Bisht

In India, a lot of companies work with companies in healthcare, banking, and manufacturing, whose operations typically rest on a very large IT system, says Primus Partners’ Dhar. “Those projects will remain. Similarly, opportunities for new projects will come up as companies in the U.S. and Europe look at cost optimisation, which means newer areas of automation,” he adds.

Light at the End of the Tunnel

A prolonged global economic slowdown will adversely impact the growth of the IT industry, but the silver lining is that the way to economic recovery will also be led by technology. “Any protracted economic slowdown in major markets like the U.S. is likely to result in short-term volatility for the IT industry, especially in projects related to discretionary spending. But economic slowdowns affect different industries differently. In the current context, technology and digital are integral to business operations in all industries, and as enterprises look to optimise their operations and innovate for growth amid uncertainties, technology is likely to take centre-stage in the recovery,” argues P.N. Sudarshan, partner and TMT Industry leader, Deloitte India.

Even during the 2008-09 global financial crisis, top-tier IT companies had witnessed double-digit growth. The story is likely to be similar this time as well, with technology led transformations leading the global economic recovery, says Sudarshan. There could be a rebalancing of opportunities in the short term, including a shift to the domestic market and emerging markets such as South Asia, South-East Asia, and West Asia. “Tailwinds like currency depreciation viz-a-viz the US dollar could be positives in favour of offshore IT vendors, to ease the short-term margin pressures to some extent,” adds Sudarshan.

The industry, meanwhile, seems resilient to the impact of a slowdown in the short term owing to a strong new deal pipeline and an uptick in other sectors — retail and consumer packaged goods, for instance, contributed 22.1% to TCS’ growth in Q2FY23 driven by travel and hospitality sectors, adds Bhatt.

Things could take a turn for the better in the job market as well. “Whenever a recession comes in and discretionary IT spends go down, attrition comes down. Salary costs also stabilise over a period of time,” says Dhar. The demand for IT skills, especially in new-age technologies and analytics are likely to increase in the medium term.

“The environment is one of cautiousness, but not of doom and gloom,” says Sangeeta Gupta, senior vice president and chief strategy officer, NASSCOM. “Most companies are seeing a steady pipeline of new business... Yes, there might be some delay in decision making but people will not suddenly cut off spending. Digital transformation is not something that you can suddenly put on hold,” she adds.

Is the U.S. Story Over?

Not really. Analysts opine the macroeconomic crisis and its bearing on the U.S. and other major economies is just a short-term blip for the IT industry and the sector has the capacity to weather the storm. While businesses may put the brakes on discretionary and large-scale transformational projects in the near-term, IT budgets related to core business operations are unlikely to take a hit.

“Enterprise IT spending is recession proof as CEOs and CFOs, rather than cutting IT budgets, increase spending on digital business initiatives. Economic turbulence will change the context for technology investments, increasing spending in some areas and accelerating decline in others, but it is not projected to materially impact the overall level of enterprise technology spending,” says John-David Lovelock, vice president, research and distinguished analyst at Gartner. The research firm estimates worldwide IT spending to total $4.6 trillion in 2023, an increase of 5.1% from 2022.

PwC’s Kumar says there may have been a shift in priority away from the growth agenda to cost optimisation in the short term, but since technology plays a key role in both initiatives, rebalancing is inevitable. “India has firmly established itself in the global market as the digital talent nation and since we will see organisations in the West undertake multiple digital initiatives, the flow of business to India will continue to be robust,” adds Kumar.

Follow us on Facebook, X, YouTube, Instagram and WhatsApp to never miss an update from Fortune India. To buy a copy, visit Amazon.