Brexit Could Hurt Indian Software Exporters

Britain’s vote to exit from the European Union has cast a pall over India’s software services industry, as fears of a freeze in technology spending and the sustained volatility in British pound could damp company earnings.
Some brokerages have lowered their earnings growth outlook for India’s outsourcing technology industry, which draws roughly a third of its revenue from Europe and up to 15% from the U.K.  Analysts fear that Britain’s move may lead the country into a recession and create uncertainty in markets across the globe, and affect the financial services industry that accounts for nearly half of the Indian software industry’s revenue.

About 52% of Britons voted last week to leave the 28-nation bloc in a referendum, sending shock waves across global financial markets as concerns loomed over a collapse of the British financial industry and the future of the E.U. Following the referendum, the British pound suffered its biggest one-day fall ever, plunging more than 10% against the dollar, and continues to remain volatile.

Bank of America-Merrill Lynch expects the earnings of IT companies to take a hit on account of the weakening of the pound and euro against the Indian rupee — though likely to be partially offset by a stronger dollar–and a growth slowdown in the U.K. The brokerage predicts Britain to slip into a recession post the exit.

“Past macro shocks like in 2009 and 2012 suggest cuts in financial services vertical tend to be steeper and swift,” the brokerage said in a note to clients on Monday. Over and above the direct revenue exposure to the U.K., technology companies are exposed to U.K. businesses of clients with a global footprint, making for a double whammy for the sector, it said.

Bank of America downgraded India’s largest outsourcing company Tata Consultancy Services to “underperform” from “buy,” saying TCS faces a bigger risk from the increased uncertainty due to its higher exposure to the U.K., as well as the financial services industry. TCS earns 14% of its revenue from the U.K. and has the highest exposure to financial services at 41%, compared with up to a 33% share of its smaller rivals.

For TCS, owned by Indian flagship conglomerate Tata Group, the macroeconomic instability could not have come at a worse time. The company, which is barely recovering from a spate of financial underperformance over the last several quarters, had in April reported a 64% increase in fourth-quarter earnings that surpassed analysts’ estimate for the first time in seven quarters.

Tata Group, which has 19 independent companies in the U.K. with diverse businesses, is one of the worst affected by Britain’s move.

Bank of America also cut its earnings estimates for the IT sector by 50 basis points to 100 basis points for fiscal years that end in March 2017 and 2018, baking in a near-term slowdown.

India’s second-largest outsourcer Infosys may not be as affected as TCS, thanks to the company’s relatively lesser exposure to the U.K. and a steady pace of deal wins over the last few quarters. Still, the domino effect of the U.K. impact on macroeconomic climate across the world poses a risk to Infosys.

“Infosys is a defensive play in the immediate short term,” Deutsche Bank said in a note on Friday. “However, we would not be surprised if the event affects Infosys’ fiscal year 2017 guidance negatively.”

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