Losing steam

The lack of a robust global recovery since 2008, protectionist tendencies in the U.S. and the uncertainty surrounding offshoring are taking the sheen off India’s IT industry.

Published : Jun 07, 2017 12:30 IST

U.S. President Donald Trump speaks before signing an executive order on visas for foreign workers, in Wisconsin on April 18.

U.S. President Donald Trump speaks before signing an executive order on visas for foreign workers, in Wisconsin on April 18.

THERE is a sense of gloom pervading India’s $150-billion information technology (IT) industry, which earned India $88 billion in foreign exchange in 2015-16 through the exports of software and IT-enabled services (ITeS). According to data from the Reserve Bank of India (RBI), the rate of growth of the combined exports of software and ITeS fell from 20.8 per cent in 2012-13 to 14.9 per cent in 2014-15 and to a low of 7.3 per cent in 2015-16. Global circumstances combined with the specific nature of India’s IT prowess seem to be responsible for this fall. India’s IT industry recorded remarkable growth over a long period because it exploited an outsourcing opportunity by perfecting a global delivery model for software and ITeS based on cheap skilled labour. That opportunity was offered by the cost-cutting imperatives facing the corporate sector in the United States and elsewhere.

As a result, IT industry revenues grew in double digits, with export earnings accounting for a large share of those revenues. Employment grew rapidly, albeit from a low base and at a lower pace than revenues. And a service industry to support the IT sector’s growth grew around the principal centres of its activity, suggesting that despite the absence of physical production the sector had backward linkages through which it delivered some economy-wide benefits. This combination of the characteristics of India’s IT success not only gave the industry a position of privilege in the economy but made it the symbol of India’s ostensible post-globalisation success.

However, there were a number of features of that model that made it vulnerable to changes in circumstances. To start with, it had a high degree of dependence on exports for growth, with the U.S. accounting for a very large share of those exports, followed by the European Union (E.U.) at a distant second. At the turn of the century, the U.S. market accounted for close to two-thirds of India’s IT exports and the E.U. for about a quarter, and even in 2015-16, the U.S. was first with 62 per cent and Europe second with 24 per cent. Little had changed for the industry.

Secondly, software services (or code writing and customisation of different levels of sophistication) and ITeS, rather than IT products, accounted for an overwhelming share of revenues. To garner those revenues, a workforce with essential IT skills and familiarity with English, communication infrastructure, and the requisite organisation were the necessary ingredients. But sustaining those revenues required constant attention to cost competitiveness, which encouraged automation of the routine activities that constitute an important part of the industry’s operations.

Thirdly, this output composition required combining offshore delivery with local services provision to understand client requirements and customise services and even run operations. So, on-site work remained an important component of the industry’s activity. In 2002-03, 48 per cent of India’s exports of IT services was through the medium of a commercial presence on foreign soil and another 13.5 per cent through the presence of natural persons. By 2015-16 those figures had come down to 18.9 per cent and 16.1 per cent respectively. But the local presence, which ensured provision of 35 per cent of the value services that had risen in value from Rs.31,100 crore to Rs.5,76,310 crore between 2002-03 and 2015-16, was undoubtedly large and crucial to the industry’s performance.

Finally, a few firms (such as Tata Consultancy Services (TCS), Infosys and Wipro) account for a very large share of the industry’s revenues, drawing attention to their operations and brand as happened in the U.S. recently.

Impact of recession Given these characteristics, a range of developments since the global crisis of 2007-08 have been posing challenges to the industry. Since the financial crisis and the Great Recession that followed originated in the U.S. and affected mainly the developed countries, the main markets of the industry have turned volatile. On average, demand growth has been sluggish by historical standards. Overall, precisely at a time when the industry had grown to maturity and was hard put to maintain market share and grow at dramatic rates, the markets themselves were losing momentum.

Moreover, the absence of any robust recovery a decade after the crisis first broke has set off protectionist tendencies. These take two forms. One is the complaint, raised during the course of the Donald Trump campaign and now influencing policy, that on-site provision of services by firms from India based on H1-B visas involves the importation of cheap labour for tasks that can be easily performed by available and unemployed local labour. If true, the consequence is the absence of adequate jobs for those who expect a higher wage. That is, the activities of India-based firms are seen as displacing jobs that could accommodate unemployed local workers.

The other effect of the recession is greater critical attention to the offshoring process, which is seen as taking U.S. jobs abroad. So, measures to cajole, persuade and/or pressure firms to not go in for offshoring, even if they find the need to outsource certain activities, is on the increase. Given the corporate interests involved here, the extent to which offshoring can be restrained is unclear. But the uncertainty it creates remains. In the event, to deal with what in its view is a “misuse” of H1-B visas, the Trump administration, under its “Hire American” programme, has chosen to set a high floor to the annual salary that must be paid to those with that visa. Trump has issued an executive order ostensibly aimed at preventing fraud in the use of such visas, and making sure that they are used only to import workers with advanced degrees and higher skills. The quality of applicants for visas is to be partly judged on the basis of the salary paid. Financial Times quoted a senior administration official as saying that “(m)ore than 80 per cent of the workers now on H1-B visas earn less than the U.S. median wage for their jobs” and “(j)ust 5 per cent have earnings in the highest wage tier”.

As a result, there is legislation being considered by the U.S. Congress that would set a floor to the annual salary of a H1-B worker at $130,000 as compared with the minimum annual salary of $60,000 currently required to be paid to staff relocated to the U.S. This would make it difficult for Indian services exporters to remain competitive without significantly reducing profits, especially since the delivery model does rely on the use of on-site workers. In addition, there is talk that the number of H1-B visas issued could be reduced from the current level of 85,000 a year. Indian citizens account for 70 per cent of those H1-B visas issued, according to data from the U.S. Department of State. So, a reduction would affect them and the firms who use them the most.

Simply put, both the high salary floor and any reduction in the number of H1-B visas will have an adverse effect on jobs for Indian workers. Already, Infosys, the largest India-based applicant for H1-B visas in the year ended September 2016, has decided to win favour with the new administration by promising to hire workers in the U.S. for local operations. In early May, Infosys announced that it would hire 10,000 workers and open four technology centres in the U.S. over the next two years. Interestingly, the first of these centres is to be located in the state of Indiana, from where Vice President Mike Pence hails. The employment bonanza for an educated Indian middle class that the IT sector offered seems to be under threat.

Meanwhile, falling revenues per employee resulting from depressed markets and non-buoyant services opportunities are forcing IT companies to think of a technology upgrade that would reduce aggregate recruitment at the margin. Routine processes are to be automated and new activities embraced that would require a smaller number of workers with newer skills. The result is a significant rise in lay-offs, which is sending tremors through the workforce but is being dismissed by the industry as normal retrenchment based on skill and performance appraisals. But, even according to industry body Nasscom (National Association of Software and Services Companies), hiring over the financial year was down to 150,000 additional jobs, compared with 230,000 three years ago.

Dismal hardware scene These causes for gloom in the Indian IT industry are likely to be compounded by parallel developments elsewhere in the industry. Those developments are attributable to a major weakness in India’s embrace of IT. India’s performance as a hardware producer has been dismal. The result has been lopsided growth focussed on software services accompanied by stagnation in hardware. Thus, a special study by the Central Statistical Organisation (CSO) undertaken in 2010 found that while the share of the information and communications technology (ICT) sector (including ITeS) in gross domestic product (GDP) had risen from 3.4 to 5.9 per cent between 2000-01 and 2007-08 (India’s high growth years), the share of ICT services in ICT GDP had risen from an already high 89.5 per cent to 94.2 per cent during those years.

More recent data from the National Science Foundation of the U.S. suggests that this lopsided growth focussed only on ICT services has continued. Thus, while value added (or revenues minus non-labour input costs) in India’s computer programming and related services industry (which excludes ITeS) rose from $2,974 million in 2000 to $19,568 million in 2014, that in the sector producing computers and office machinery rose from $209 million in 2000 to $775 million in 2011 before falling to $281 million in 2014. The overall picture was one of stagnation in the latter industry, with the share of the former in value added in both activities put together rising from 93.4 per cent to 98.6 per cent between 2000 and 2014.

Unfortunately, the stagnation in domestic hardware production has occurred in a period when computer use has been rising rapidly in the country and the government has been pushing for computerisation—in its own departments, in the banking sector and among the public at large. As a result, even by 2012, India was among the top 10 countries in the world in terms of personal computer use, with an installed base of 57 million personal computers. According to the International Telecommunications Union, the percentage of households in India with a computer rose from 6 per cent to 13 per cent just between 2010 and 2014. This rapid expansion combined with the large size of the population that is still digitally excluded points to the possibility of an explosion in hardware use.

The consequence of the combination of stagnation in production and expansion in use, according to data from the World Trade Organisation (WTO), has been a significant increase in the imports of computer hardware. Thus, imports of electronic data processing and office equipment rose in value from $1,413 million in 2000 to $4,481 million in 2008, and after a marginal fall in crisis year 2009, resumed its climb to reach $8,293 million in 2015. This climb is bound to continue and even gather pace.

It is in this light that India’s success as a software services exporter has to be assessed. While it is true that exports of computer services and ITeS have risen from $16 billion in 2005 to $35 billion in 2008 and then (after the 2009 fall) further to $52 billion in 2011-12 and $88 billion in 2015-16, the pace of growth has slowed sharply in recent years. Not surprisingly, WTO data suggest that the ability of the IT sector to earn the foreign exchange needed to finance the imports of IT hardware has been shrinking. The ratio of computer hardware imports to exports of computer services, which was falling prior to the 2008 financial crisis, has since shown signs of rising.

The problem is that the failure to develop a domestic hardware base is not restricted to computers alone but is characteristic of the ICT sector as a whole, which is increasingly the sector of relevance given the rapid spread of mobile telephony and the substitution of communication devices for many operations earlier conducted with computers. Overall imports of ICT hardware into India have soared, especially after the boom in mobile telephony.

On the other hand, overall ICT exports still largely comprise and have been driven by IT and ITeS. Thus, once we shift attention to the ICT sector as a whole, the shortfall in software export earnings relative to expenditure on hardware imports is not an imminent danger but a current affliction. The ratio of dollar earnings from ICT services exports to expenditure on ICT hardware imports has fluctuated between just 3 and 4 per cent in all but one year over the last decade. Thus, while India’s foray into software and ITeS exports has been remarkable, that growth has not just been slowing but loses a lot of its lustre when seen in light of the dismal performance of the country in hardware production. Not only is ICT a small component of the economy, lopsided growth even in this small segment can have extremely adverse balance of payments implications. In that case, the coming crisis can have damaging consequences for the economy, even if India’s software czars remain among the wealthiest in the world.

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