Banking crisis in the West to further hurt revenue growth of IT services firms in 2023-24 fiscal

Software services exporters were already staring at a growth slowdown in 2023-24 financial year, amid recessionary fears in major markets like Europe and USA as global central banks tightened liquidity and raised interest rates sharply to tame record high inflation. The headwinds only grew as the high interest rates hit a few regional US banks. This has further clouded the growth outlook for large as well as small software companies.

Credit ratings agency CRISIL expects revenue growth of the information technology (IT) services sector in India to decline 700-900 basis points (7-9 per cent) in the financial year ending March 2024 to around 10-12 per cent. This is in sharp contrast to a strong 18-20 per cent growth IT companies are expected to report in the 2022-23 financial year, aided by 7-8 per cent rupee depreciation to the dollar. Even in the 2021-22 financial year, IT companies saw 19 per cent revenue growth.

Europe and North America are major markets for software exporters. While the slowing economic growth in many countries there had already cast a shadow on the growth outlook for these companies, the crisis in the banking system has added to the challenges.

Three regional US banks collapsed in March. The worries over the health of Swiss banking giant Credit Suisse and its quick sale to rival UBS added to the concerns. Banking, financial services and insurance (BFSI) accounts for 30 per cent of the IT sector's revenues, followed by retail and consumer packaged goods with 15 per cent, according to CRISIL.

"Headwinds in key markets, especially the BFSI segment in the US and Europe, will affect the revenue growth of domestic IT services companies. While BFSI segment revenue growth is expected to halve to mid-single digit, it would be marginally offset by 12-14 per cent growth in the manufacturing segment and 9-11 per cent growth in other segments. Net-net, there would be moderation in overall revenue growth," said Anuj Sethi, senior director, CRISIL Ratings.

Even as BFSI demand is expected to slow, growth in cost-optimisation deals, digital solutions, cloud and automation capabilities, is expected to support wider demand. Also, despite the revenue growth slowdown, operating profits are likely to grow around 50-60 basis points to 23 per cent in 2023-24, as IT firms are seen reigning in employee costs and cut back on new hiring, CRISIL said.

CRISIL is not the only one flagging slowdown concerns for IT companies. Analysts at Kotak Institutional Equities also see the revenue growth outlook for software companies to be modest in FY2024.

Kotak cut FY2024-25 expected revenue growth for IT companies by 1-2 per cent baking in "additional headwinds from the recent deterioration in BFS outlook" and expects the big three (Tata Consultancy Services, Infosys and HCL Tech) to report 7-8 per cent revenue growth in the 2024 financial year.

"We expect subdued demand outlook on near-term tech spending. Banking crisis in US regional banks and European banks can induce greater caution and impact overall tech spends by banking clients. The demand outlook of segments such as mortgages, hi-tech, and certain segments of retail and telecom is weak. We expect macro uncertainties to limit near-term demand visibility," said Kawaljeet Saluja of Kotak Institutional Equities.

Motilal Oswal Financial Services has also cut its earnings growth estimates for IT companies by 1 per cent to 4 per cent for FY2024.

"Though the Indian IT services firms do not have meaningful exposure to the affected US regional banks, fears of a banking crisis could impact near-term IT spending by banks and will be the key monitorable during the fourth quarter management commentary," said Pritesh Thakkar, analyst at Motilal Oswal.

Apart from BFSI, hi-tech, manufacturing and retail sectors could also report muted growth in the March quarter as clients have started to cut discretionary spends, while increasing focus on cost efficiency, he added.