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India's largest offshore outsourcers may have survived the downturn, but Western economics are threatening long-term profitability

India’s IT outsourcing industry felt the impact of the global recession as hard as any. As businesses postponed long-term outsourcing decisions, the industry’s rapid revenue growth was cut back to a crawl.

In the past six months, though, the industry has been getting back to business. Infosys, the country’s second-largest IT provider, is a case in point. During the three-month period ending 30 September 2010, the company registered 29.6% sales growth to $1.5 billion alongside a profit rise of 18% to $374 million.

Now, though, the challenge facing the Indian IT sector is not the recession itself, but the measures that Western economies are taking to curtail its long-term impact. And while the pressures of the past 24 months have eased, the ongoing profitability of India’s world-beating outsourcing business is still under question.

The industry’s most important market has always been the US, and it is there that anti-globalisation rhetoric is most conspicuous. This summer, US Congress passed legislation doubling the cost of migrant worker visas. The move was seen as a shot at Indian companies, which often send workers to the US to work on their clients’ premises.

“The cost impact factored in will not be significant to us,” says BG Srinivas, Infosys’s head of manufacturing and products. However, he acknowledges that the sentiment behind that legislation could spell trouble in the future: “If there are regulations that prevent [employee] mobility, then that is something we need to worry about.”

Infosys is also concerned about developments in the UK, where the coalition government intends to impose an as yet undefined cap on immigration. Prime minister David Cameron has indicated that this cap will not restrain inter-company transfers, used by outsourcing companies to move their employees across international borders, but nothing is yet set in stone.

“We will have better clarity when the government come out and articulate what this means,” Srinivas explains. “So far, the UK government has been pretty open in listening to the industry and organisations such as us. They are able to understand how companies such as Infosys are making UK businesses competitive.” He says that Infosys is in dialogue with Westminster via Indian IT trade body Nasscom.

Nevertheless, Infosys acknowledges that these changing sentiments require it – and the Indian IT industry at large – to modify its geographical model. Speaking at the All India Management Association in October 2010, the company’s founder, NR Narayana Murthy, said the sector needs to make greater use of local human resources. “Hire local talent,” he advised his peers. “Hire Englishmen in England, Americans in the US and Brazilians in Brazil. The solution for us is to make the front end local, then no-one will raise any objection.”

All the while, Infosys and its peers are still wrestling with economic factors that impact on profit margins, most notably currency fluctuation. In October 2010, the rupee reached a 25-month high against the US dollar, meaning that the money Indian companies earn in the US is worth less in their home currency.

Indeed, so grave is the situation that in October Infosys’s CFO, V Balakrishnan, called on the Reserve Bank of India to devalue the Indian currency, saying that “[currency fluctuation] will kill the whole export industry”.

Another ongoing challenge is wage inflation: the average wage in India is expected to rise 10.2% in 2010. “We have to make sure we increase productivity, increase efficiencies, automate and use other levers to offset wage inflation,” Srinivas asserts, admitting that one such mechanism is “price increases”.

He insists, though, that it will be a while before the cost advantage of labour arbitrage in India is completely eroded. “Like-for-like, there is still a huge gap to fill between the developed economies and the wage levels in India.”