Jeremy Warner: Indian IT takes a further knock

Outlook Recent events have dealt the Indian IT services sector, the subcontinent's biggest industrial success story of recent years, a triple whammy. First there was the meltdown in global financial services, the outsourcing sector's biggest single customer group. Then came the terrorist atrocities in Mumbai. Outsourcing relies heavily on regular, face-to-face contact between contractors. The deliberate targeting of foreigners by terrorists has made some US and European companies wary about the necessary travel to India. Even a year ago, it was virtually impossible to find a room for the night in Bangalore. Today, the hotels are virtually empty.

Then came news that Satyam Computer Services, the fourth largest player in India's oursourcing sector, has been cooking the books. If it is true that Ramalinga Raju, the former chief executive, had in recent months been sustaining the salary bill only by selling shares in the company, then Satyam may soon be out of business altogether, dealing a further hammer blow to an industry that depends vitally on confidence to win clients.

Companies that have become unduly reliant through outsourcing on Satyam's services could find themselves in serious trouble. Even a couple of days outage for these services can more than wipe out the cost benefits that companies derive from outsourcing. All over the developed world, companies will be re-examining security of supply from their outsourcing contractors.

Confidence in the industry's standards of corporate governance has been further damaged by news that the World Bank is blacklisting Wipro and others for allegedly providing "improper benefits" to bank staff to win contracts. Wipro's sins, which go back to 2000 when "family and friends" of World Bank officials were offered favourable treatment in a listing of shares, are of a less serious nature than Satyam's. The infringements took place at the height of the dotcom bubble when such practices were commonplace. Nonetheless, the World Bank's action all these years later in blacklisting Wipro will further undermine confidence in the sector.

All this is occurring against the backdrop of what may become a quite vicious protectionist backlash against outsourcing to the developing world as global economic activity contracts. As more companies bring services back in house because of fears about reliability, security and to protect domestic jobs, is the outsourcing phenomenon heading for the buffers?

In the short term, there may indeed be a quite severe correction, though there was scant evidence of it in final quarter figures from Infosys yesterday, which showed continued strong growth. Unfortunately, this is pretty unlikely to persist, notwithstanding the business Infosys expects to pick up from Satyam.

IT services are a classic "late-cycle" industry, in that spending on IT tends to survive unscathed until comparatively late in the downturn before plunging like everything else into the abyss. At the very least, recent levels of soaraway growth will abate sharply from here on in. Yet, once present corporate governance and recessionary woes are overcome, the longer-term outlook still looks good. Demographics alone should ensure the outsourcing phenomenon has got quite a bit of mileage left in it yet. An ageing population in Europe means growing reliance on the more youthful demographic profile of the developing world to perform back-office functions.

The strong euro ought further to enhance the competitive advantage enjoyed by India and other parts of the developing world on labour and other costs. For the time being, however, India's outsourcers will undoubtedly struggle.