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Will the IT ministry be a bane for the infotech sector?

Give us infrastructure and leave us alone." That's IT professional Subroto Bagchi's prescription for his industry. The vice-president of Mindtree is an acknowledged expert and people in the IT industry pay large consultancy fees for his advice. So, naturally the new government is going to ignore it when it is available for free.

The government probably isn't going to develop acceptable infrastructure at anything like the necessary speed to sustain growth in this sector. And, if early signals are anything to go by, it certainly isn't going to leave the industry alone.

What's worse is that the global environment is starting to look shaky just as the government decides that IT must be the unwilling beneficiary of its hamhanded benevolence. Even as Satyam Infoway follows Infosys onto Nasdaq and a host of other Indian IT companies queue up for listings on American bourses, the underpinnings are being removed.

IT in India has many problems and a few competitive advantages. Let us list the advantages first. Training people is cheap -- one reason being that the government spends Rs 23,000 crore annually in subsidising higher education. Salaries of software professionals are low in comparison to OECD nations. The industry has been left more or less to its own devices by the Indian government until recently. The NRI community has a huge presence in the global IT business. This means that new Indian start-ups always get breaks when they look for either business or capital abroad.

Now let us look at some of the problems. First of all, infrastructure costs in India are very high. In addition, reliable high bandwidth telecom connections and stable power are simply unavailable in most areas. Power is perhaps twice as expensive and telecom charges are anything between 40 to 140 times as expensive as in OECD countries. The cost differentials are so disparate that an Indian IT company spends at least 40 per cent more than a comparable American operation on its overheads.

If the government actually wanted to help the IT industry and every resident Indian into the bargain, it would sort out these two sectors. The ground reality is that it can't -- or won't. Telecom remains a Godalmighty mess, five years after it was supposedly opened up. Until the government wields a scalpel on its own monopolies and empowers the Telecom Regulatory Authority of India, there is no hope of improvement here. In the context of IT, power is less important because alternative, albeit expensive, sources of reliable power exist. The industry can live with the current situation and its inherent inefficiencies.

The third problem is the lack of sane legislation. For the last three years, the RBI has "thought" about e-commerce and its possibilities and problems. Until such time as the central bank stops thinking and drafts legislation that makes online commercial transactions legally enforceable, there is a big roadblock.

The finance ministry causes a further roadblock. The sales tax/ excise tax treatment of an online transaction is presumably going to require several years of "thought" by the mandarins of that ministry. Also, the tax treatment of ESOPs (employee stock option plans), which have been integral to financing the global IT revolution, is painful. As per the current Indian treatment, ESOPs will never work. The tax liability is incurred even before the employee has cashed his notional profits, and it is applied at the highest marginal rate of short-term capital gains.

So, the Indian IT industry already lives with problems caused by the power ministry, the telecom ministry, the RBI, the finance ministry, the ministry of commerce. It will now have to make allowances for the newly created IT ministry as well. The new ministry will presumably "direct" the IT industry to evolve in the way it considers desirable. The concept has been tried before by Japan's MITI. As a result, Japan has the least IT knowhow in the First World -- India has a larger chunk of world IT exports than Japan. The other inevitable problem with a new ministry is that it will fight turf wars with all the other ministries that now impinge on its interests.

One final point about government interference. The GOI considers industries like mines, steel, power, aviation, and telecom to be of such vital importance that their every step must be dictated by ministries, devoted to creating policy. The impact of that benevolent interest in the case of each industry is apparent. Is there any reason to believe that the GoI will perform any better with regard to IT?

That's not the end of the problem. Globally, the Y2K problem and contracts for its solution will wind up very soon. India earns close to 35 per cent of its current IT revenues from this cul-de-sac. The next two, three quarters will thus see many Indian companies scrambling for new avenues of income.

Already, unpleasant earnings surprises are showing up in Q2 results. The next two quarters will be worse. Huge populations of software engineers will have to be re-trained. Companies will have to find means of cutting themselves slices of higher-end markets.

God forbid, but if the USA moves into a recessive cycle, the world IT trade may collapse. And recession in America looks more than likely on the law of averages. You have had an uninhibited expansion for nine years. If the Fed raises interest rates as Alan Greenspan is threatening to do, it may spark a recession. The new IT initiative to list on NASDAQ and find foreign venture capital will then burst along with the US market bubble.

Don't get me wrong. I think IT will maintain good growth rates. But with price-earnings discounts averaging 100-plus in the industry, the earnings-growth rates also have to be triple digit. Indeed they have been, this far. But the above trends will ensure that growth rates drop to 20 to 30 per cent for at least 2,3 quarters. Some companies will actually see shrinkage in bottomlines. Inevitably the market will downgrade the industry.

IT stock prices will see a huge correction as the market adjusts. When will IT stocks crash? Perhaps on the day the new IT ministry issues its first directive! Perhaps on the day Greenspan raises American interest rates and Wall Street and Nasdaq start spinning down.

I would wait until that correction before I bought my next IT stock. Of course, a breakthrough in telecom policy and sensible legislation vis-a-vis ESOPs and e-commerce coupled with a swift abolition of the new IT ministry would change my mind!

Devangshu Datta

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