IT services sector to witness a slump in revenue growth of 3%, FY24: ICRA

According to ICRA, the Indian IT services sector is projected to experience a deceleration in revenue growth, expected to reach three percent in the ongoing fiscal year, in contrast to the 9.2 percent achieved in the previous financial year.

The profitability will also slow down in this financial year and the operating profit margin will narrow by up to 1 percentage point to 20-21 per cent, said ICRA Ratings.

 The topline growth will come down to 3-5 percent in FY24 from the 9.2 percent posted in FY23, the agency said, attributing the slowdown to softening demand.

Deepak Jotwani, Assistant Vice President & Sector Head, ICRA said, “ICRA expects moderate revenue growth of 3-5% in USD terms (for its sample set) in FY2024, lower than ~9.2% YoY growth in FY2023 owing to persistent uncertainty in the key markets, resulting in pauses and deferral of non-critical projects and slowdown in discretionary IT spends by key sectors like BFSI, retail, technology and communication. Moreover, the operating profit margin (OPM) for the sample set is expected to decline by 70-100 bps in FY2024, due to lower operating leverage. Nevertheless, it will remain healthy at 20-21% in FY2024, owing to the ability of most companies to work with multiple levers such as onshore-offshore mix, employee utilization levels, and employee pyramid optimization, among others, to manage costs”.

Indian IT services companies witnessed a sharp moderation in growth momentum over Q3 FY2023 – Q1 FY2024 owing to the evolving macroeconomic headwinds in key markets of the US and Europe. In Q1 FY2024, ICRA’s sample set recorded a revenue growth of ~3.8% on a YoY basis in USD terms, the lowest in the last 10 quarters. In terms of geography-wise trends, the growth in the US witnessed a sharp moderation compared to that in Europe.

Analyzing growth trends across different segments, it is evident that Banking, Financial Services, and Insurance (BFSI) as well as the communication sector have witnessed a more pronounced deceleration compared to other segments. The BFSI domain has been influenced by a subdued performance in mortgage lending, investment banking, capital markets, and insurance segments. This underperformance is attributed to the prevailing macroeconomic challenges. On the other hand, the communication vertical has encountered setbacks due to the diminished revenue trajectories of telecom firms. The initial projections of substantial investments in 5G have not manifested as expected, prompting a reevaluation of technology expenditure priorities.

Though the revenue conversion of the orders slowed down, the order book and deal pipeline of most companies remained strong. Moreover, evolving consumer demand dynamics, post the pandemic, have made technology spending far more integral to the overall capital allocation of corporates. Therefore, ICRA expects a likely pick-up in the growth momentum once the macroeconomic headwinds subside by the end of the current fiscal.

There has been a significant reduction in hiring by IT services companies in the last three quarters, given the slowdown in the growth momentum, coupled with the utilization of the considerable excess capacity added in FY2022 and H1 FY2023. Moreover, with easing demand-supply mismatches, there has been a considerable tapering in attrition levels in recent times. “ICRA expects lower hiring by the IT services companies in the near term because of the expected slowdown in growth and also estimates attrition to further decline over the next few quarters before stabilizing at the long-term average of 13-15%,” Jotwani added.

The Indian IT services sector maintains a net cash surplus stance, bolstered by robust liquidity resulting from significant operational cash inflows and conservative capital expenditure and working capital needs. Even amidst substantial dividend disbursements, share buybacks, and strategic acquisitions, ICRA anticipates that most industry participants will uphold a resilient financial outlook. This expectation rests on the foundation of robust cash flow generation, limited debt exposure, and ample liquidity.