Historically, a Fed rate cut cycle has often signalled the end of a period of high demand for IT services exports, leading to an economic slowdown.
The Federal Reserve is set to announce a rate cut today, which could influence global markets in various ways. But what does this mean for the Indian IT services sector?
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Historically, a Fed rate cut cycle has often signalled the end of a period of high demand for IT services exports, leading to an economic slowdown. However, this time, experts are hopeful that the situation might be different.
“Historically, Indian markets have tended to fall after a Fed rate cut, as these cuts are often a signal of economic weakness that can trigger risk-off across the globe. Investors get scared of an impending recession and pull themselves back from so-called riskier assets, which place Indian markets in that bracket, too,” said Dr Ravi Singh- SVP Retail Research, Religare broking.
According to JM Financial, the current cycle of rate cuts could be unique. Indian IT firms, which are coming out of a period of spending adjustments, may not face the same recessionary pressures as in previous cycles.
Although recent job market data might raise some concerns, the impact on IT spending—already streamlined—could be less severe than expected.
This shift in outlook brings optimism to major IT players like Infosys, Tech Mahindra, and Wipro. As the cost of equity potentially falls and market multiples adjust, these companies could benefit from both increased discretionary spending and lower operational costs. However, while some positive effects are already visible in stock prices, the full impact of reduced interest rates might take some time to materialise.
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JM Financial suggests that this time could be distinct because Indian IT companies are likely to emerge from a spending adjustment phase. Moreover, the risk of a recession appears lower this time.
A technical impact of the rate cut is the potential for a lower cost of equity, which translates to higher price-to-earnings ratios (PER).
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JM Financial has said that for the first time since 2007, US 10-year bond yields have been higher than Nifty IT’s earnings yield. This suggests that anticipated bond yield declines could already be reflected in stock prices.
In practical terms, JM Financial believes that lower interest rates should particularly benefit the Communications, Media, and Entertainment (CME) and manufacturing sectors. Tech Mahindra, with a 53% exposure to these sectors, is well-positioned to gain. On the other hand, a revival in US bank spending could provide a boost to Infosys, Tata Consultancy Services (TCS), and Wipro.
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Overall, JM Financial predicts that Fed rate cut cycles generally lead to a lower cost of equity and drive up stock multiples, boosting discretionary demand as the economy recovers. Lower interest burdens on corporations also create room for higher operational expenses.
While the first factor—higher multiples—has already had some effect, the second factor depends on the economy’s recovery trajectory, which remains uncertain. The most immediate effect is the reduced interest burden.
JM Financial mentions that the rise in corporate interest costs has been gradual compared to the Fed rate changes.
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Most sectors have slightly reduced their leverage over the past four years. This trend suggests that companies have adjusted their debt and operations to handle higher interest costs. This adjustment is especially notable in the Manufacturing and CME sectors, benefiting Tech Mahindra.
Expecting an immediate boost in corporate spending might be premature, but JM Financial’s optimism is based on the anticipated easing of the spending adjustment cycle.
For investors, Infosys, Tech Mahindra, and Wipro are among the preferred large-cap stocks, while Persistent Systems and KPIT Technologies are recommended in the mid-cap space.
