Rate cuts to boost top line of IT firms

Uncertainty around the inflation trajectory weighed on client decision making and revival in discretionary spending, with a full-fledged demand recovery now expected only in CY25 (2025) or FY26 - Emkay Global in a note

Bottom Line Pressure

• 2024 likely to see tepid top line growth among IT firms
• Jefferies pointed out margin to remain under pressure in FY25
• Bank of Canada, ECB lowered interest rates
• Labour market and US economy appear to be slowing
• After surprising strong jobs data, US Fed may wait for more data

Bengaluru: Interest rate cuts by various central banks across the US, Europe & Canada are likely to trigger discretionary spending among enterprises, giving fillip to growth rates of IT services firms globally.

Brokerage firms are of the opinion that after Canada and European Central Bank (ECB) cut interest rates recently, the US Federal Reserve may follow suit. If this happens, Indian IT firms will see more digital spends coming back to the market.

“Start of the interest rate-cut cycle would act as a signalling trigger for clients gaining confidence on inflation trajectory and macro stability, which may drive demand recovery and an uptick in discretionary spending, in our view,” Emkay Global, a brokerage firm, said in a note.

“Uncertainty around the inflation trajectory weighed on client decision making and revival in discretionary spending, with a full-fledged demand recovery now expected only in CY25 (2025) or FY26,” it added.

Bank of Canada became the first central bank among G-7 countries to reduce interest rate by 25 basis points last week. Similarly, the European Central Bank lowered the interest rate by 25 basis points last Friday for the first time since 2019 amid elections.

These rate cuts have raised hopes of interest rate reduction by the US Federal Reserve in coming days.

“The labour market and the US economy both appear to be slowing, but the surprisingly strong job data on (last) Friday will probably push the Fed to wait for more data (to assess), to gain confidence on the slowdown in activity and inflation before taking a rate cut decision,” the report noted.

The brokerage firm also noted that revenue growth continued to remain challenging in a tough macro environment.

“Revenue growth continues to be impacted by a challenging macro environment, slower decision making, and softness in verticals like BFSI, retail, Hi-Tech, and communications. Amid the challenging demand environment, players are witnessing increased mix of cost takeouts and vendor consolidation deals that usually have longer tenure, thus leading to slower revenue conversion,” the brokerage firm noted.

Meanwhile, global brokerage firm Jefferies in a note said that margins of IT firms would continue to remain under pressure in the current financial year.

“The consensus expectation is an 80 basis points year-on-year (YoY) increase, reaching 20.3 per cent for the sector. However, while there’s optimism for a significant 380bps improvement (240bps adjusted for one-off items) in Tech Mahindra, the outlook for other IT firms suggests only a modest 20-80bps rise,” the brokerage firm said in the report. It also highlighted several challenges that might prevent these margins from expanding as expected, posing potential risks to earnings.