Demand uncertainty in IT persists, FY24 will be a mean reversion towards growth, says JPMorgan

A: I'll frame the conversation in three ways. One, clearly there is increasing appreciation that the demand environment has worsened in June. We've continued to see the trends that the sector faced in the month of March, which was actually a lot weaker, perhaps in the March quarter. So we think that will somehow come through and we are expecting a June quarter, which will be muted as a result of that.

But moreover, not just that, there's been an expectation that demand and perhaps company performance might recover later in the year, either in the second half of the calendar or the second half of the financial. And our conversations with the industry suggest that may not happen, the demand uncertainty persists, I think enterprises are just not keen to commit to a recovery in the medium to short term.

And the third way I'll frame this is in the context of the growth we've seen in the sector over the years. So clearly, the sector enjoyed very strong growth momentum in 2021-2022, as we were recovering from the post-COVID phase. However, the main thing here is we are seeing a mean reversion. I don't think FY24 necessarily is an exception. It's a mean reversion towards long-term growth. And I think the question that investors should be really debating about is what is the long-term growth for the industry? We think it's about 7-8 percent, 6-8 percent, and not high single digits. So I think those are the three things I will want to focus on.

A: If one looks at the long-term trend of IT services growth for the industry and general globally, you'll notice that IT services growth tends to track global GDP growth quite closely as the industry in India has grown dramatically. The market share for the sector has grown and the premium of growth that Indian IT services can grow at has shrunk because of this base effect.

Now, one of the analysis we had done recently, we just tracked the total revenues for the entire IT services sector in India. And compare what would have happened if there was no COVID. For example, from 2019, if we just extrapolated the growth rate over the last five years and look at what the growth rate would have been, our analysis suggested that if there was no COVID, the revenues for the industry will be pretty much what we saw in the March quarter. So basically, we were just going through a skew in spending, spending was pushed out in 2020, and it was pulled forward to an extent in 2021-2022. And now we sort of heading back to where the industry growth can be. And we think that's more like 7-8 percent and expectation of growth going back to the COVID years, is something that we will be very surprised to see. Because of the change that's happening and to your point, I think a lot of CEOs, a lot of CFOs are realizing there is no urgency to tech spend right now. And hence we sort of go back to the medium-term to long-term trends in terms of where people think about how much enterprises will spend on IT services.

A: I think to start with we do think that FY25 estimates remain very high. We don't think the growth in the sector can go back to double-digit sustainably. As I said, we think the growth sustainably is about high single digits. And what makes us say this is I think we just look at the medium to long-term trends and the period that people tend to frame the focus on in going back to double digits is basically looking at just the last two years. But if one looks at the long 15 to 20-year history, that's not been the case. Now, to your point, in terms of the recovery in tech spend as the data improves - what's different here is that when one looks at the data that we're looking at right now is consumer data. Indian IT companies, customers, and enterprises - enterprises actually been going through an earnings recession. While there's not been a recession in the US so far, there still has been an earnings recession in the S&P 500 and that's what enterprises are reacting to. That's point number one. Point number two is - let's assume that enterprises do see a better demand environment. IT services tend to be a cyclical industry. So we'll see that with a bit of a lag. At the moment, there are no indicators to suggest that enterprise expense is improving.

A: The way generative AI will impact the industry is clearly one of the questions which is - one of the key conversation or debate points among all industry participants, whether it is CEOs or whether it is investors, our current perception is that this is clearly one of the big disruptors for the industry in the medium to long term. We think the first level of impact will be an element of deflation, a lot of the mid to low-end work that IT services companies provide whether it's application testing, to an extent application maintenance, infrastructure maintenance, business processes that can be partially automated where one can see a significant amount of potential deflation on spending.

In the medium to longer term, there should be more opportunities as industries evolve, as we move to higher levels of technology abstraction, as new work comes in. But unfortunately, that work typically does not come to IT services firms, or at least IT services firms with the technology heritage to begin with. It tends to go to consulting heritage firms to start with. So we think in the medium term, we would expect some deflation. It's very early to say what that level of deflation would be, it is hard to quantify right now. But we think that can depress growth in the medium term, let's say 25-26-27.