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Subprime mortgage mess not affecting Indian offshoring -- yet

Linda Tucci, Executive Editor
The subprime mortgage mess wending its ugly way through the world's largest banks has not yet significantly affected the Indian offshore industry, said experts on both sides of the ocean. But that could change if the housing slump triggers a broader recession, forcing price adjustments, contract delays and changes in personnel from Indian providers doing business with U.S. companies.

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The mortgage sector accounts for about 3% of the overall Indian offshore market, according to Technology Partners International Inc. (TPI), the independent sourcing advisory firm headquartered in The Woodlands, Texas. Small Indian players that relied on subprime lenders for much of their revenue are in trouble, forecasting lower earnings or worse, said Kashyap Kompella, advisor, global service delivery, at TPI. But the top 10 Indian providers, where exposure to the mortgage sector hovers around 1%, are weathering the crisis and -- so far -- aren't seeing an appreciable decline in demand for offshore services.

Indeed, double-digit growth is still the norm at the big firms. Infosys Technologies Ltd. in Bangalore, for example, reported revenue growth of 19% over the same period last year and a 19% increase in net earnings for the quarter ending Sept. 30. Operating margins improved slightly, despite the rising valuation of the rupee against the dollar. Wipro Ltd. saw revenue jump 35% in the second quarter compared with the same period last year. Net income rose 17% for Wipro, but operating margins were down 240 basis points, due to the depreciation of dollar, the company said.

If the U.S. housing slump becomes a full-blown recession, however, even the most successful Indian providers could face dramatic declines in revenues, Kompella said.

"Given that the U.S. market is their largest market, if this snowballs into a longer recession, that is really a problem for them," Kompella said, in part because of the nature of the contracts. Unlike the U.S. outsourcing industry, which makes its money from long-term maintenance contracts, a big chunk of the work the U.S. sends to India comes out of discretionary budgets.

"In a cooling economy, discretionary budgets are put on hold," Kompella said. Even if the Indian providers do not lose contracts in a cooling economy, their chances of growing their U.S. clients' contracts by adding innovative, high-value services will be severely constricted, he added.

Balaji Yellavalli, head of consulting and solutions at Fremont, Calif.-based Infosys Banking and Capital Markets Group, puts his group's ratio of discretionary and nondiscretionary work at 50-50, although he conceded that the split depends on how one defines those terms. He said he's seeing "some knee-jerk reactions here and there" from the company's large banking clients, but nondiscretionary spending has continued for ongoing, "keep the lights on"-type projects.

That said, it will be some time before the impact of the mortgage crisis is known, because discretionary spending is typically planned with a six- to 12-month time frame. "So decisions taken today may impact us a couple of quarters down the line. We don't know," Yellavalli said. One positive result is clients are starting to ask for better controls and better risk-rating models toward lending.

Meantime, the response on U.S. shores to economic indicators swings wildly from day to day. An Oct. 31 report from the Department of Commerce said the U.S. gross domestic product grew 3.9% in the third quarter, the fastest growth rate in 1½ years, suggesting that the economy is holding its own against the housing market, which continued its tumble during the same period. The following day, the Dow Jones industrial average fell nearly 300 points on forecasts of sluggish job growth, which turned out to be false. Payrolls surged by 166,000 jobs in October.

Sense of urgency

Recession or no recession, the mortgage meltdown has brought into sharp relief inherent challenges in the Indian offshore industry -- in particular, the eroding margins of Indian providers due to wage increases and the rising valuation of the rupee, said Kompella and others who track the industry.

The big story in Indian outsourcing is the availability of talent and the pressure that puts on wages, which have risen an average 12% to 15% per year during the past few years. Another drag on earnings is the current weakness of the dollar. The Indian rupee has appreciated 12% against the dollar since January. While revenue for Indian providers comes mostly in dollars, the majority of their costs are in the rupee.

All this has created a sense of urgency among Indian providers to increase productivity, diversify their client base by targeting non-U.S. markets, step up their efforts to recruit entry-level employees and improve their ability to calibrate supply and demand. The rising valuation of the rupee has also raised interest among Indian providers in acquiring Western companies.

Think ahead, think twice

The levers that Indian providers are using to protect their margins -- diversification, improved productivity, cheaper labor -- are affecting how contracts are structured, and CIOs should plan accordingly, Kompella said.

If this snowballs into a longer recession,
that is really
a problem
for them.

Kashyap Kompella
advisor, global service deliveryTechnology Partners International Inc.
For one, vendors are carrying smaller "benches," or staffs for projects. This can mean longer lead times for starting projects -- as much as two to four weeks more than the usual two- to three-month ramp-up time. Kompella advises you give your provider as much notice as possible.

Second, think twice about going with a smaller player. While smaller players often offer more flexibility and attention for your money, they're less able to withstand macroeconomic shocks. Vendor viability rises to the top of the agenda in uncertain economic times.

Third, as vendors increase their intake of junior-level employees to build reserves and save money on salaries, you need to scrutinize whether you're getting people with the requisite skills for your project.

Finally, don't be surprised when vendors ask for price increases. Your response obviously depends on the situation. If you need access to niche skills not available elsewhere, you may have to pay the higher price point.

Let us know what you think about the story; email: Linda Tucci, Senior News Writer


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