Indian IT services vendors have had several reasons to be nervous of late – well, as nervous as one can get when your company’s revenue growth is north of 25% and your operating margin exceeds 20%.

Rupee appreciation, domestic salary inflation, pressure in the US banking market and mounting anti-offshoring rhetoric from the US Presidential candidates have sent jitters through the stock prices of the top Indian suppliers, and prompted some to write rather premature obituaries on the Indian IT export market: http://www.forbes.com/technology/enterprisetech/2008/02/29/mitra-india-outsourcing-tech-enter-cx_sm_0229outsource.html

And another issue that is keeping some awake at night is whether the Indian Government will extend the IT sector’s tax breaks that are due to end in 2009. One of the major factors behind the Indian IT sourcing phenomenon was the development of Software Technology Parks of India (STPI) in 1991, in which companies operating in designated areas qualified for a ten-year income tax exemption.

Debate has raged in India as to whether a country with such a huge need for public infrastructure investment, can afford not to tax some of the most successful multi-billion dollar enterprises doing business in its cities.

There was no mention of an STPI extension in the Government’s latest budget, announced earlier this month. But the vast majority of the vendors I have spoken with in the last couple of months are cautiously optimistic that the Indian Government will extend the tax breaks within the zones beyond the current deadline.

Industry association NASSCOM continues to push hard for an extension, and representatives from the Ministry of Communications and IT has been making positive noises about it in the Indian press and at recent conferences

This is partly because the Indian Government has become anxious that the country’s national champions may up sticks, and take their business out of India to alternative sourcing locations.

It will be a long time before China’s IT services export industry achieves the same scale and maturity as that of India. But already, Indian and Western services vendors have set their sights beyond the over-heating labour markets in Bangalore and Mumbai, and are setting up in cities such as Chennai and Gurgaon: http://www.reuters.com/article/rbssTechMediaTelecomNews/idUSDEL5984620080325

And of greater concern to the Indian Government is that all of the country’s tier-one vendors are setting up secondary sourcing centres in Latin America, Eastern Europe and Eastern Asia. Countries such as the Philippines and Vietnam have learned from India’s success and are offering tax holidays of their own.

NASSCOM believes that the non-extension of the tax break would land a crippling blow to the Indian IT industry, resulting in the loss of some 400,000 jobs in the medium term.

This is a tough call for the Indian Government to make, and one that echoes the recent crackdown by the UK Government on non-domicile taxation. With less than two years to go before deadline day, it doesn’t have much time to make up its mind.

Offshore gains a foothold in UK public sector

Government has long been seen as the last sector that would open its arms to global sourcing.

Offshoring is a sensitive issue for any business, but stir in public data protection laws, strong unionization and the close scrutiny of the national media, and it is easy to see why the government space does not account for a significant chunk of the Indian suppliers’ revenue – less than 2% for the top five players in the UK.

But while we are very unlikely to see any public sector bodies enter into deals that would cut UK public sector jobs and replace them with offshore labour, there are increasing opportunities for both offshore specialists and Western companies to use their global sourcing capabilities on government projects.

This was highlighted when Indian vendor HCL Technologies recently won a $4m deal with Wiltshire Police Force to build a remote working system to enable officers to access vital information while in the field. HCL is implementing the system and will provide ongoing support over the next five years, but will not handle any sensitive data as part of the contract.

Cash-strapped government organizations are becoming more open to utilizing global delivery, particularly on the ‘build’ part of IT projects. In public healthcare, TCS and Infosys have both worked for the NHS for several years, and TCS has just been named as one of the health service’s approved ASCC suppliers.

Don’t be surprised to see offshore services vendors in the hunt for future government sector business. They aren’t going to oust the likes of EDS, Fujitsu from IBM on public sector outsourcing engagements, but there is enough project work out there for it to represent a pretty big growth opportunity.