Global ratings agency Fitch has affirmed a stable outlook for the India information technology (IT) services sector in 2012 on account of its strong liquidity position, even though it warned that revenue growth of the segment may moderate this year.
Employee hiring increased in 2011 in anticipation of improving demand in the sector, resulting in higher wage costs; and thus negatively impacted EBIDTA (Earnings Before Interest Depreciation Taxes and Amortization) margins for the nine-month period ended December 2011. The moderation in revenue growth is likely to exert further margin pressures. The depreciating Indian rupee, which lost around 15% of its value against the US dollar during January-December 2011, is likely to provide some relief to the margins over the short-term as about 60% of Indian IT export contracts are USD-denominated. However, over the medium-term, some of the advantage may erode due to the increasing competition.
Fitch believes that the liquidity of the Indian IT services companies would remain comfortable in 2012, backed by their high cash balances, low debt levels and positive free cash flows from the recurring and critical nature of IT services. However, demand contraction due to a double-dip recession and /or any increase in M&A activity, large dividend payouts, share buybacks and/or an expansion in receivables periods are the key risks to liquidity.
The outlook could be revised to negative if there is a sustained decline in EBIDTA margins, leading to a reduction in liquidity. Factors that are likely to negatively impact EBIDTA margins are demand slowdown and /or increased competition, leading to price reductions. The ratings of individual companies could be adversely affected by event risks such as acquisitions and shareholder-friendly actions which would either drain liquidity or result in a material increase in debt levels. Any adverse change in the proportion of offshoring/outsourcing revenues due to regulatory developments could also affect the sector negatively.