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Business trends

India's IT sector feels squeeze of higher US labor costs

After strong quarter, TCS and Infosys face further changes to visa rules ahead

Infosys employees relax in a cafeteria at the company's Bangalore campus. Indian IT services groups' labor-intensive business model has been tested by stricter U.S. visa rules.   © Reuters

MUMBAI -- India's leading information technology companies have posted strong quarterly results, but the worries for this export-oriented sector are not over, with more changes to U.S. work visa rules on the way, threatening their business model.

Industry leader Tata Consultancy Services, second-ranked Infosys and smaller Wipro and HCL Technologies have long relied on abundant low-cost Indian labor, including workers sent to the U.S., their most important market.

With the U.S. tightening rules for the H1-B visa program, which lets American employers hire foreigners in certain skilled fields, Indian IT companies face higher labor costs as they replace Indian engineers with better-paid U.S. workers. Indians account for a wide majority of H1-B visa holders.

Tata Consultancy, Infosys and HCL all beat beat analyst estimates for the quarter ended in September, helped by a slump in the rupee, a revival in big-ticket orders, and increased revenue from digital technology businesses for most. However, labor cost increases squeezed operating profit margins.

Wipro, which reported earnings on Wednesday, took the biggest hit, with its operating margin falling to 14.6% from 17.2% a quarter earlier and 17.3% a year ago. Net profit dropped 9.9% on the quarter to 18.86 billion rupees ($258 million) on revenue of 145.57 billion rupees.

HCL Technologies, which posted a 16% rise in net profit to 25.4 billion rupees on revenue of 148.6 billion rupees, saw its margin grow by just 0.2 percentage point to 19.9%.

Margins at Infosys, despite a better-than-expected 10% rise in net profit to 41.1 billion rupees, were little changed at 23.7%. The company has also given a lower guidance for margin growth during the financial year ending in April 2018.

Tata Consultancy Services, on the other hand, reported a 23% jump in quarterly net profit to 79.01 billion rupees on revenue of 368.54 billion rupees. Its margins rose 1.44 percentage points to 26.5% after booking several big orders.

Madhu Babu, a research analyst at Indian brokerage Prabhudas Lilladher, said that IT services companies' margins have not expanded at the same pace as the rupee has declined "because all that you are getting from the currency is going in for payments such as [high salaries to local staff in the U.S.]."

Fears over changing H-1B visa rules are nothing new for Indian IT companies, which have been gearing up to increase American hiring since the start of U.S. President Donald Trump's administration in 2016. Infosys, for instance, has promised to hire 10,000 people in the U.S., and has fulfilled nearly half of that commitment already.

Earlier this month, Washington said it is planning to "revise" the definition of specialty occupations and employee relations under the H-1B visa program by next year, among other changes. According to U.S. Citizenship and Immigration Services, around 419,637 people worked in the U.S. on H-1B visas as of Oct. 5 and 309,986 of them were Indians.

These changes, according to Kotak Institutional Equities, could lead to higher costs -- potentially a hit of 2.5 to 3.3 percentage points to EBIT (earnings before interest and taxes) margins -- as well as problems meeting customer demand for some companies.

On-site salary costs for top Indian IT companies come to 38% to 45% of revenues, Kotak said in a note. These companies derive around 58% of their revenues from the U.S., with a lower figure for Tata Consultancy Services and a higher ratio for HCL Technologies, according to the note.

Adding to the Indian tech sector's woes are macroeconomic uncertainties caused by Britain's looming exit from the European Union and the ongoing trade war between the U.S. and China. Global companies have been putting off decisions on new IT budgets as they wait for more clarity on Brexit negotiations, and now businesses fear Britain will crash out of the EU in March without any transition agreement.

All this comes at a time when the Indian companies are trying to come out of several quarters of low growth, losses of important deals, and a hard transition from labor-intensive work to internet-based services.

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