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The flourishing IT & ITeS may face some challenges in the coming months. Since the US financial market is witnessing a downturn, the dollar is on a dive, higher taxes and salaries are eroding margins and clients are reluctant to negotiate on higher price. All these factors will make life challenging for the IT and BPO companies, which have been used to fast growth and expansion over the past several years.

This slowdown in the US economy will have an impact on the large companies more, compared to smaller IT companies. Most of the large banks work primarily with the top tier Indian IT companies, who will be impacted the most, as their clients report losses and go bankrupt. UBS declared a loss of $13bn. Bears Stearns had to sell off to JP Morgan for $236 million as it was reported that the former booked a loss of over $2.6bn. Citibank is planning to restructure its India BPO operations as it has declared a loss of $24 bn. There are almost at least one center in India for these big financial institutions.  Satyam handled Bear Stearns, Citibank does its business with its captive E- serve in India.

There may be a slowdown in the IT and BPO industry however it would not stop altogether.  Though some maintain that there will be greater outsourcing and more deals (though in the range of $30-$70 million in the next 12-18 months, as valuations have come down. It is estimated that a consolidation in vendor base as companies move towards financial restructuring and look towards cutting costs in the medium term. Critical outsourcing work like applications maintenance and infrastructure management will continue. But as things subside we may see greater outsourcing.

It is expected that the yearly top line and bottom-line growth for the top five IT players may be taper this year. We expect top-tier IT companies (Infosys, TCS, Wipro, Satyam and HCL) to record around 20- 25 % year-on -year top-line growth in FY-2009, driven mainly by volumes and pricing-led improvements. If there is any further appreciation of the rupee against the greenback is also likely to put further pressure on growth rates. Consequently, we expect 50100 bps year-on-year margin contractions for these companies, which is likely to lead to slower EPS growth of 15-18% yearly.

The IT Stocks are to be handled with caution, as believed by many analysts. Since the beating they have taken over the past year, downside risks are limited for IT stocks. The dramatic re- ratings of these stocks are not likely in the near future. The investors must be patient if they plan to be buyers of IT stocks and expectations must also be toned down by market realities. We believe a 15 % annual return is not unreasonable to expect from top-tier IT stocks going ahead.

In between all this the companies are looking to expand their businesses in the Tier II and Tier III cities. This is to fight rising salaries and to reduce the impact of rising taxes. The Indian BPO companies are at an flexion point. The challenge for them is how to move from the tried and tested labour arbitrage model to value added services. More focus on domestic market will be seen and salary growth will obviously taper down to 10-12 % per annum from 18 % last year.