Why Indian IT thinks Brexit is terrible news

India’s outsourcing industry, already in the midst of massive change brought about by cloud computing and other new ways their customers view technology, will be hit badly by Britain’s decision on Thursday to leave the European Union.

That sentiment is reflected in the 2.5 percent fall in both the BSE-IT index and the broader Sensex in Mumbai trading at around 2 pm local time.

Pre-Brexit Europe represented the biggest market for India’s IT industry after America, and typically Britain accounts for the biggest share of their revenues from Europe. That is set to change. 

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“It will have a major impact, may not be for FY17, but definitely for FY18 and FY19, there will be a significant impact, I think the industry as a whole is likely to lose 2-3 percentage points of growth,” Rostow Ravanan, CEO of Bengaluru’s IT services company Mindtree, said in a phone interview.

“It is definitely a momentous occasion, just like the creation of the euro or the fall of the Berlin wall. In terms of the impact of this occasion, it is as momentous as that,” and it will affect everybody, including European businesses and UK-oriented companies and global corporations as well, he said.

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“The Europe market is of prime importance to India,” the National Association of Software and Services Companies, India’s biggest tech lobby, said in a statement on Friday. Europe is the second largest market for the Indian IT and business process management industry, constituting almost 30 percent of the industry’s export revenue of about $100 billion, according to Nasscom.

The UK plays a key role within this market. In addition to representing a large share of Nasscom members’ operations in Europe, many use the UK as a gateway for further investment across the European Union, the lobby said.

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In the longer run, Nasscom says there might be some positives as well: With the existing 800 Indian companies employing 110,000 individuals in the country, a deeper partnership with India may be in Britain’s interest, according to Nasscom.

With UK less dependent on intra-EU immigration into the UK, it could become more open to high-skilled immigration from other non-EU countries, including India. Further, the UK would be under no obligation to adopt restrictive EU data localisation norms which it does not subscribe to in their entirety. All these factors could benefit India-UK bilateral economic relations, the lobby said in its statement.

In its initial analysis of the near-term impact of Brexit, however, Nasscom lists the following: likely decline in the value of the British pound, which could render many existing contracts losing propositions unless they are renegotiated. The uncertainty surrounding protracted negotiations on the terms of exit and future engagement with EU could impact decision-making for large projects; Indian IT companies may need to establish separate headquarters/operations for EU, it may lead to some disinvestment from the UK; skilled labour mobility across EU and UK could be impacted; and there could be changes in the financial system, banks and impact on currency.

Consider a German business and say they have a data centre in Germany, servicing customers across Europe. Now they can’t host data of UK customers in Germany. This means they will have to create another data centre in UK. Such things will come at a cost, Ravanan points out.

He has another example: Many companies globally as well as in Europe have their tax headquarters in locations such as Ireland for the lower taxation regime. Such arrangements will no longer be valid, which means an undoing of their corporate structures and therefore IT systems as well.

The question that needs to be answered is what are the terms under which Britain will leave, as the EU treaty has a “guillotine clause” — if a member leaves the EU, it can’t keep somethings and leave others, he said.

A host of complications will now have to be dealt with, including questions like what if other member states want to leave or if EU wants a member out, what happens to past financial transactions, subsidies and so on. Then there are geopolitical considerations such as how will Brexit affect Nato for instance.

All this means the EU, in its current form, as the largest trading block, outside the US, with the rest of the world, will go through a lot of adjustments. The UK itself will go through a prolonged period change on many front, from governance to economy—with a high potential for a recession in the country, he said.

Financial services, one of the biggest components of the UK economy will obviously have a major period of change. All these put together, it is an event that will have a massive impact on businesses and consequently all supplier industries, including India’s outsourcing vendors, he said.

“It will be major, it isn’t something one can shrug off in a couple of quarters, but the quantum is difficult to estimate now,” Ravanan said. For the Indian IT industry as a whole, “there will definitely be cancellations and delays in decision making, re-prioritisation of IT, which will be non-trivial.”

That re-prioritisation will mean, for instance, diverting money budgeted for a nice-to-have discretionary project to say help an FMCG company get closer to its customer to a must-have project in order to comply with the new tax and other regulatory compliance regimes that will follow Britain’s exit.

“There would be a delay for sure in coming to decisions especially on the discretionary spending,” Arup Roy, a research director at tech consultancy Gartner, said in a phone interview. That is typically associated with consulting and systems integration projects, and providers with higher exposure to such businesses would get impacted in the near term.

Innovation-led projects also tend to be in that category largely, in the discretionary area. In the short term, that will be put on the backburner for sure, particulary in verticals such as banking, insurance and financial services, Roy said.

Even when, eventually, projects are handed out to modify business, IT systems based on the form Brexit takes, say a year down the line, those projects will be unattractive. They will be highly cost-competitive and won’t help grow the Indian companies’ margins.

Nor will companies that have limited exposure to Britain be spared, Ravanan argues, as this is such a monumental change that global businesses around the world will be affected. “At the end of the day, if a tsunami hits you, whether you are 50 metres from the shore or 100 metres from the shore, doesn’t really matter, everybody will get flooded.”