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Foreign investors continue to see dark clouds on the horizon for the Indian IT sector. Foreign portfolio investors (FPIs), renowned for spotting long-term structural bets, remain net sellers in the ‘Software & services’ sector. The sector witnessed a net outflow of close to ₹17,000 crore in the first half of the current financial year.
According to data available with depositories, FPIs pulled out ₹16,818 crore from the equity segment of the Software & services sector in the April-September period. The net outflow, which is the highest in a single financial year, is also 74 per cent higher than the ₹9,649 crore pulled out during the comparable period last year.
FPIs have been on a selling spree in the sector for quite some time. The sector has seen the second highest erosion of FPI investments in FY19 after the auto sector, with a net outflow of ₹10,113 crore.
Macroeconomic concerns
The Indian IT sector is plagued by a range of macroeconomic concerns. The slowdown in Europe (a major growth driver) and softening US Yields (which curtail spending in the Banking and Financial Services sector) are some of the major concerns portending a gloomy outlook for the industry.
Read also: FPIs invested over Rs 3,800 crore into Indian markets in October
“Cross-currency headwinds, muted outlook by management, slowing BFSI due to a potentially weaker macros in developed markets meant that these (IT) stocks seemed fairly valued in the background of slowing topline growth and an expected squeeze on margins,” said Deepak Jasani, Head Retail Research, HDFC Securities.
“Hence, despite the fact that IT services form a large weight of major indices, investors have chosen to cut their weights in them,” Jasani added.
For instance, Tata Consultancy Services (TCS), which is India’s largest IT services firm by revenue, posted single-digit revenue growth for the second quarter, after four quarters of double-digit growth. The company’s lower growth was attributed to the volatility in the global financial services sector.
Margin pressure
IT companies are also facing margin pressure due to high costs and a relatively stable currency. In a research note on the IT services sector, Kotak Institutional Equities Research said lower profitability (of IT companies) is due to a couple of factors, such as an increase in the US operations cost structure in the form of higher subcontracting and higher localisation due to talent shortage and tightening of the visa regime and transition costs in large deals.
The report also added that IT companies are investing in the digital business, which includes infrastructure, reskilling of the workforce, investments in sales and marketing, development of an alliance ecosystem and compensation measures to retain key talent in new technology areas.
Silver linings
However, things are not all that gloomy for the sector, which enjoys a core competency in IT services. Market analysts believe that visibility of increased spending on IT services in developed economies could turn sentiments for the better.
Edelweiss Securities, in its recent research report, said that it is bullish on India's IT sector. “Record deal-wins, an encouraging deal pipeline and sanguine management commentaries on demand strengthen our conviction in Indian IT’s solid earnings trajectory,” Edelweiss wrote in its outlook for the sector.
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