?Capitalism at the crossroads? screamed a newspaper headline on the current European crisis. Capitalism, which was the buzzword for globalisation, innovation and economic prosperity, is suddenly seen as a problem impacting global growth. The western world, which is the biggest proponent of capitalism and free market economy, is suddenly seeing capitalism as a ?sin? that is the source for all the trouble in their economies.
The current European crisis has the potential to impact global growth, which is already anaemic with no signs of any recovery. The European Union, with no single fiscal and monetary union, is finding it difficult to come to a common solution to the problem affecting the eurozone. Already, we are seeing escalating frictions between the political system and the capital markets.
The capital markets are sending a clear message to the political parties to either change or face the consequences. The markets have forced changes in the political leadership in Greece and Italy, by replacing the popular government with well-known technocrats. The rating agencies are constantly downgrading the developed economies, which are not actively seen as taking steps to come back to fiscal prudence. Who would have thought that the US will lose its AAA rating one day? The friction between the popular political leadership and the capital markets is only increasing by the day.
What is the chance of a breaking up of the EU? Today, a section of the markets believes that the eurozone breaking up is a real possibility. Otherwise, how would you explain two large economies within the eurozone?Germany and Italy?being treated differently by the markets? The former is borrowing at a negative yield while the later is borrowing at high single-digit yields. Both are part of the same currency union with integrated monetary policies. If the EU breaks and some of the countries in Europe default, then it will have a catastrophic impact on the rest of the world. Most of the corporates are getting ready for such an eventuality.
Today, most of the tier-1 players in the IT services industry get around 20-25% of their revenues from Europe. Most of those revenues come from the UK and the exposure of the Indian IT services industry to the troubled countries in Europe is very low.
So, what does the eurozone crisis mean to the IT services industry in India? The IT services industry in India has seen two recessions in the past?one was the dotcom bubble in 2001 and the other the financial crisis in 2008. In both these recessions, the Indian IT services industry came out a winner. Of course, there was a short-term impact on its growth rate when the recession happened. However, when confidence returned in the developed economies after the recession, the growth in the IT services industry came back with a bang.
Two scenarios are possible on the European crisis. The first one is that the EU finds its way out of the crisis one way or another. The political leadership in Europe will take incremental baby steps to address the problem and come out of the mess. Europe is not the US. You can?t expect any big bang approaches to the problem in Europe like what we saw in the US. But, the fact of the matter is that it is not in anybody?s interest to allow Europe to fail. Eventually, a solution would be found and the eurozone will come back to the recovery path.
In such a scenario, the world will see an extended period of economic uncertainty and slower growth. The clients? budgets, which are the normal barometer of IT spending, will have less relevance in such a scenario. In an extended period of uncertainty, what is relevant is the clients? willingness to spend rather than the IT budgets. With the 2008 financial crisis fresh in the minds of the clients, they will be extra cautious in spending the money and will focus rather on cash conservation. This scenario may not be bad for the IT services industry in India. Outsourcing and offshoring will be a big winner when clients focus on efficiency and try to get more work done out of smaller budgets. Also, Europe, excluding the UK, is traditionally a closed market with the level of outsourcing/offshoring lower compared to the US. So, I believe that such a scenario will result in increased outsourcing/offshoring opportunities from Europe for the Indian IT services companies. The only challenge could be that the spending won?t be a straight line but could be volatile, in line with the clients? confidence on how the macro economy is evolving.
The second scenario could be the break-up of the EU, which looks like a possibility today. Such an event could be catastrophic for the global economy. It will have a bigger impact on the global markets than what we saw during the Lehman collapse. Europe being the world?s second largest economic unit, such a scenario will impact all companies in all sectors and geographies. There could be a temporary freeze on all spending, including the IT services spending. Clients will be very cautious on their spending, even for the ?lights-on? kind of projects. The recovery in IT spending will purely depend on how fast the world finds its balance and recovers.
Eventually, corporates have to spend money on IT to retain their competitiveness and efficiency. Technology will remain the key differentiator for corporates to win back business and compete. Also, the need for innovation and new advancements in technology will provide enough opportunities for growth to the IT services industry in India.
My belief always had been that the Indian IT services industry is to some extent hedged on both sides. When the world is at stress, outsourcing/offshoring increases as clients seek more efficiency to free up their cash resources. When the world recovers, there is greater IT spending to enhance competitiveness and growth and that benefits the industry. However, sudden shocks in the global economy will always have some short-term impact on the industry. But, if you take a medium- to long-term view there are enough opportunities for growth for the Indian IT services industry.
The author is CFO of Infosys