Does India's IT Sector Reflect Recovery in the West?

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India's top two exporters of software services - Tata Consultancy Services (TCS) and Infosys - surprised the markets this week with strong 2012 fourth quarter earnings, pointing to a recovery in demand from their key markets, the United States and Europe.

India's $100 billion information technology services sector is largely dependent on western demand, with more than 75 percent of revenue for both TCS and Infosys, for example, coming from North America and Europe.

While a pullback in global technology spending amid an uncertain economic climate, has impacted India's IT sector in recent months, now the tide seems to be turning with both companies offering an optimistic outlook for the coming months, particularly regarding demand out of Europe.

(Read More: India's Infosys Unexpectedly Raises Forecast, Shares Surge)

"Companies in Europe are definitely driving optimism and efficiency. And that is opening up opportunities. We are working with a large number of European clients and we are signing deal sizes which are larger than it used to be before," TCS CEO N. Chandrasekaran told CNBC TV-18 on Tuesday after announcing quarterly results.

The company's profit rose by a better-than-expected 23 percent in October-December, from a year earlier. It reiterated that revenue for its fiscal year that ends in March should outpace forecasts by the sector's industry body National Association of Software and Service Companies, which expects growth to come in at the lower end of 11-14 percent.

(Read More: India's TCS Shares Surge on 'Picture Perfect' Earnings)

Infosys board member and former CFO, V Balakrishnan, added that while there are a lot of challenges in Europe, client spending is increasing. "They [ Western corporates] are offshoring to gain some efficiency in their operations."

The company secured eight large outsourcing deals, worth $731 million - seven of which were located in Europe and the U.S. – over October to December.

(Read More: Europe Looks Good; Won't Clip Pricing to Drive Revenue: Infosys)

Overall, the Bangalore-based firm, which unexpectedly raised its annual revenue forecast after reporting earnings that beat estimates, said it remained "cautiously optimistic" for the remainder of the fiscal year.

Infosys has had a string of disappointing earnings performances in the recent quarters. For the July-September quarter, the company's earnings just about met market expectations, following lower-than-expected profits in the previous three months. TCS, on the other hand, has seen resilient earnings due to its focus on the traditional outsourcing business, which has held up as companies cut costs.

In 2012, global headwinds including escalating euro zone debt crisis and U.S. growth concerns led corporates to delay their technology investment decisions.

However, global IT spending is projected to rise to $3.7 trillion in 2013, a more than 4 percent increase from 2012 spending of $3.6 trillion, according to research firm Gartner.

"With U.S. elections and 'fiscal cliff' issues behind us and sentiment improving, we believe that possibility of an uptick in IT spends remains high," Surendra Goyal, director and head of research at Citi wrote in a report.

Discretionary Spending Key

Goyal added that one segment he will be watching closely for a clearer indicator of demand is discretionary IT spending, or non-essential initiatives that can be pulled back when times are tough.

Both TCS and Infosys saw an uptick in discretionary spending in the last quarter, he said. "Both Infosys and TCS saw good growth in consulting and package implementation - which are discretionary in nature - if this sustains, it will tie in with a better demand environment," said Goyal.

Package implementation is a service provided by IT firms to assist companies in implementing and maintaining software they have purchased.

"The increase in spending is tied to the stability in Europe and the U.S. When things are uncertain, clients don't make decisions, even if they make economic sense. Now that confidence is there, decisions are being taken, which is a big help for India's IT sector," he added.

Pankaj Kapoor, diretor at Standard Chartered Securities, however, said it remains unclear whether discretionary demand will continue to improve.

"I would be cautious in the outlook for discretionary spending - the economic environment hasn't improved so much that people are committing money to long-term technology projects," he said.

"It's too early to extrapolate the latest quarter's results into what we can expect for fiscal year 2014," Kapoor added.

Wipro, India's third largest software services provider, which is due to release its latest earnings on Friday, will provide further clarity on how the sector is faring. The company is expected to report a quarterly profit gain of 6.7 percent, according to Reuters.