Empirical Analysis of Growth of Software Industry during the Economic Reforms Period in India Dr. Sanjay Tupe* Associate Professor and Head, Dept. of Banking and Finance B.Y.K. College of Commerce, Nashik-5, India (Affiliated to University of Pune) Abstract To account the growth of Indian software industry during the economic reforms and to seek answer to a research question whether software industry has done well or not during the economic reforms period? For that, we use different econometric techniques: Log linear model, F test techniques and dummy variable regression model have been used. Results show that after the introduction of economic reforms, total value of software sales and software export earnings got declined. However, software sales in the domestic market rose by 3 percent during the economic reforms period. In addition to log linear model, Chow test is used to test stability of parameters, it proved that there is no structural change in the total value of software export earnings even though new economic reforms have been implemented. Keywords: India, Information Technology Firms, Software Export, BPO, KPO, Economic Reforms. JEL Classification: O1,O2,O3,O5,O21. * Author can be reached at Email: sanjaytupein@yahoo.co.in Mobile: 09960278899 1
Empirical Analysis of Growth of Software Industry during the Economic Reforms Period in India 1. Introduction Information technology has been fostering the process of world integration by way of increasing use of internet. It is now possible to download information from any part of the world after the introduction of World Wide Web (WWW). Internet economy has been growing by leaps and bounds. Now it becomes very powerful mechanism of modern market. In USA, internet economy accounts for US $ 270 billion in 1998 as against energy (US $ 223 billion) and automobiles (US $ 350 billion). Indian e-commerce market has been expanding rapidly from Rs. 19,688 crore by the end of 2009 to Rs. 45,520 crore by end of 2011. Among the various constitutes of e-commerce market in India; on line travel business share is 76 per cent which is highest. The new knowledge economy has been thus creating high quality employment. It has reshaped the job market in the USA, Europe and also in the Asian countries. Present IT jobs did not exist prior to 1994-95 in the world job market. Indian IT industry provides services such as application, development and maintenance in which it has been emerging as a leading player on the world map due to advantages of quality and cost-effectiveness in services that is being offered to overseas clients. It also provides service of product testing and infrastructure management. New services are being offered such as value chain, delivery of analytics and knowledge management, financial and technological solution to small and medium term enterprises, centric delivery models, reengineering of the firms and plants and many more services to overseas and domestic clients. The Indian IT sector has been merging as knowledge power for US and Europe clients due to rich talent and laborious attitude of the techno-savvy generation towards the given assignment. In this paper, we empirically test the impact of new economic reforms on the growth of Indian software industry. Using various econometric techniques, before economic reforms and after introduction of economic reforms growth rate of software export is measured and comparison is done to know change in the growth story of Indian software firms during these 2
periods. This paper begins with introduction. Section 2 deals with share of software services into total exports from India and its proportion in GDP. The development of Indian software industry is reviewed in this section. Section 3 analyses the impact of the economic reforms on the growth of Indian software industry. Section 4 verifies the structural changes in the Indian software export earning using dummy regression. Section 5 concludes the present paper. Dossan and Kenney (2007) review the growth and development of software firms in India since 1980.They find that India has its own dynamic and software development work done in this regard, which can further attract off shore work. To reap the advantages to globalization, Indian people should learn and upgrade their skills for further development of IT firms. Moitra (2001) observes that five factors contributed for the growth of software industry in India: quality and talent of manpower, world- class quality and high process maturity, competitive costs structure, rapid delivery capability, and English speaking pool. Therefore it grows annually by 50%. It becomes driver of economic development and major driver of foreign exchange earnings. Arora et al, (2001) find that Indian software industry is maturing slowly and growing with their capability and not only that it acquired the ability to execute big and complex projects. A large number of software firms in India have come up as startups, showing that the supply of entrepreneurial talent appears to be forthcoming when opportunity arises, even in new and technology intensive sectors. Most of the Indian software industry is of flat kind of organization managed by relatively young, talented, dynamic and laborious technocrats. Bhatnagar (2006) concludes that good university education system is necessary to get ready manpower besides policy and incentives support for the further development of software industry in India. 2. Share of Software Exports in Total Exports and GDP Table 1 provides information about the share IT (Information Technology) software exports in total exports made from India. It may be noted that IT exports was accounted for 0.33 percent in 1985-86 per cent of the total exports and then it increased to 1.29 percent when new economic reforms were introduced in India. Subsequently, it shot up to 34.39 percent by 2010-11. Now, IT exports occupied prime place into composition of total exports. Consistent 3
demand from the U.S. increased its share in total exports of India s ITs and ITeS services from 61.5 per cent to 62 per cent in 2011-12. Emerging market of Asia pacific and rest of the world also contributed to overall growth of the software industry in India. There is a great demand for IT services not only in traditional sector such as banking, financial services and the insurance companies but also in new emerging verticals of retail, healthcare, media, and utilities. Obviously, IT export becomes significant for India and if the same trend remain continues, this sector may emerge as the major export-earner for Indian economy in near future. So far as the contribution of Indian software industry is concerned, its share into GDP of India has been consistently growing from 0.01 per cent in 1986-87 to 9.84 per cent in 2011-12. This achievement is significant for changing the structure of international trade from India to the rest of the world. India exported software products and services to 132 countries in 2002-03 that list rose to 145 countries in 2010-11. 2.1 Share of Software Exports into Total Value of Software Table 2 shows the trends in software sale revenue (international and domestic). In the column 5 ratio of software export to total value of software production from India depicts that before liberalization, value of software export was marginal and not only that it was below the domestic software sale (Rs.101 crore). However, after the introduction of new economic reforms since 1991, the share of software export picked up from 56 per cent. Again from the year 1998-99, it accelerated from 77 percent and reached to 81 percent. These trends clearly show that software export has dominated software business over the domestic software sale in India. Hence, it is necessary to protect the interest of software exporting firms. Since these firms bring foreign exchange and contribute into the exchequer smartly. It is necessary to protect the interest of these firms by extending more fiscal incentives and infrastructure support to them. Domestic software market can be expanded by articulating friendly policies. Indian domestic software market is also a strong market considering population and living style of the people along with rising trends in their personal income. Government is the principal agency for purchase of products of IT industry; which accounts for 34 per cent of the total domestic 4
software market share. This is followed by banking and finances 18 per cent, manufacturing 12 per cent and telecom 10 per cent. These four sectors account for 74 per cent of (nearly three fourth) share of the domestic IT market. Besides, there are some minor contributors as transportation, health sector, oil and petrochemicals and retail trade. Year Table 1 Share of IT Software s and Services GDP at Factor cost in Rs. Crore Software export in Rs. Crore Total Indian Export in Rs Crore Software export to GDP in % Software export to total export in % 1986-87 815049 34 10249.9 0.00 0.33 1987-88 850217 49 12040.7 0.01 0.41 1988-89 880267 70 15024.9 0.01 0.47 1989-90 969702 101 19726.5 0.01 0.51 1990-91 1029178 175 26961.8 0.02 0.65 1991-92 1083572 250 31619.8 0.02 0.79 1992-93 1099072 410 43019.5 0.04 0.95 1993-94 1158025 675 52309.0 0.06 1.29 1994-95 1223816 1020 68503.6 0.08 1.49 1995-96 1302076 1535 81365.1 0.12 1.89 1996-97 1396974 2520 104835.6 0.18 2.40 1997-98 1508378 3900 117106.7 0.26 3.33 1998-99 1573263 10940 128789.7 0.70 8.49 1999-00 1678410 17150 139376.9 1.02 12.30 2000-01 1786525 28350 159392.9 1.59 17.79 2001-02 1864301 36500 195029.3 1.96 18.72 2002-03 1972606 46100 198911.4 2.34 23.18 2003-04 2048286 58240 242668.1 2.84 24.00 2004-05 2222758 80180 276969.3 3.61 28.95 2005-06 2388768 104000 343935.4 4.35 30.24 2006-07 2616101 141800 404885.1 5.42 35.02 2007-08 2871120 164400 487259.1 5.73 33.74 2008-09 3129717 216190 541671.8 6.91 39.91 2009-10 3339375 237000 717357.2 7.10 33.04 2010-11 3446133 268610 712635.0 7.79 37.69 2011-12 3379844 332415 966693.5 9.84 34.39 Source: Compiled and computed from the data provided by NASSCOM and Hand book of statistics on Indian economy, RBI (2012). 2.2World Market for Computer Software and Services Export It is evident from Table 3 that though India is not a major player of software export in the world but it has occupied prominent place after Japan in the Asia continent. America is number one amongst the software and related services exporter to the extent of 39 percent 5
followed by 34 percent from Europe. India s share in software export is 7.8 percent; which is much higher than China due to the favorable factors exist in India such as education system is based on British education system, English speaking personnel and IT savvy youth manpower, cost reduction is up to 50 percent, wage differential, lower infrastructure costs, favorable time lag 12 Hrs for the USA and 5 Hrs for Europe and India given degree to 22,000 engineers every year. China has been trying to take over India in the next five years in this regard. Year Software export in Rs. Crore Table 2 Trend in Software Sales Revenue Domestic in Rs Crore Total Value in Rs. Crore Export to Total Value in % 1985-86 34 64 98 34.69 1986-87 49 106 155 31.61 1987-88 70 115 185 37.84 1988-89 101 140 241 41.91 1989-90 175 170 345 50.72 1990-91 250 225 475 52.63 1991-92 410 320 730 56.16 1992-93 675 490 1165 57.94 1993-94 1020 695 1715 59.48 1994-95 1535 1070 2605 58.93 1995-96 2520 1670 4190 60.14 1996-97 3900 2410 6310 61.81 1997-98 10940 3510 14450 75.71 1998-99 17150 4950 22100 77.60 1999-00 28350 7200 35550 79.75 2000-01 36500 10874 47374 77.05 2001-02 46100 13400 59500 77.48 2002-03 58240 16250 74490 78.18 2003-04 80180 21740 101920 78.67 2004-05 104000 29600 133600 77.84 2005-06 141800 37000 178800 79.31 2006-07 164400 47300 211700 77.65 2007-08 216190 49000 265190 81.52 2008-09 237000 67800 304800 77.76 2009-10 268610 78700 347310 77.34 2010-11 332415 91765 424180 78.37 Source: Compiled and computed from the data provided by NASSCOM and Hand book of statistics on Indian economy, RBI (2012. 6
2.3 Exporter of Computer Services Top 10 Firms Indian software industry has been growing at exponentially and entered into the supply chain. Initially it was started considering as cost effective staff for the software development and performing a task of back office operation through BPO and KPO. Now, it has been emerged as suppliers of world class engineers and consulting talents. Table 4 shows the top 10 Indian firms of software exporters. All these firms acclaimed the name and fame and also trust of the foreign corporate firms, banks, financial institutions and various foreign government departments for maintaining quality in the assignment, punctuality and cost effectiveness in the work. Table 3 World Market of Computer Software and Services Export at End of 2010-11 Countries exporting Software and related services percentage U.S.A 39 Japan 12 China 6 Europe 34 India 7.8 others 1.2 Source: Electronics and Computer Software Export Promotion Council (ESC), Statistical Year Book 2010-11. Tata Consultancy Services Ltd., Infosys BPO Ltd., Wipro Ltd are the pioneering private sector firms which have established the foundation of Indian software industry. All these firms have opened up their branch offices in the leading cities of the world. Indian software firms are being exporting computer software and services to more than 145 counties. Almost all the leading foreign IT firms and new firms have established either back offices or subsidiaries or collaborative offices in India to tap the technically qualified vast manpower and at low cost of wages. Indian IT firms have also a presence in USA and Europe thorough subsidiaries, back office operation etc. 7
Table 4 Exporter of Computer Services Top 10 Firms Sr. No Company Total Export during 2010-11 Rs. Lacs US $ Million 1 Tata Consultancy Services Ltd 2428900.00 5119.94 2 Infosys BPO Ltd. 2114100.00 4456.37 3 Wipro Ltd 1668100.00 3516.23 4 Cognizant Technology Solutions India Pvt. Ltd 1558100.00 3284.36 5 HCL Technologies 1010400.00 2129.85 6 IBM India Pvt. Ltd 644200.00 1357.93 7 Accenture Services Pvt. Ltd 446400.00 940.98 8 Tech Mahindra Ltd 429700.00 905.78 9 Mphasis Ltd 387400.00 816.61 10 Patni Computer Systems Ltd 296100.00 624.16 Source: Electronics and Computer Software Export Promotion Council (ESC), Statistical Year Book 2010-11. 3. Trends in Growth of Software Industry in India Software industry is of recent origin for India. With an advancement of computer by generation and penetration of computer knowledge in the western world, its use begins from the year 1985 in India. However, its growth spread after the International Treaty of 1994 and introduction of New Economic Programme (NEP) since 1991. Since then the export of software products and related service has been increasing from India. There is gradual use of IT in government offices, public sector, service sector, private sector, academic and research institutions, NGOs and corporate sector. To account for the growth of Indian software industry during the economic reforms and to seek the answer of a research question such as whether during the economic reforms period the software industry has done well or not? For that, we use different econometric techniques or methods to account the performance of Indian software industry. Among them the Log linear model, F test techniques and dummy variable regression model have been used in the subsequent section of the present paper. 8
3.1 Growth of Software Industry before Liberalization and After Liberalization of Indian Economy Growth of any economy or sector or firm or industry can be tracked down by using certain parameters such as size of profit, sales, export earnings, gross domestic product, per capital income, employment potential and so on. In order to know the impact of economic reforms on growth of software industry India, we use variables like Indian software export and related services earnings (ISEX), software sales in domestic market (DMSS), and total value of software sales (TVSS). Dummy variable is used to make distinction between period before the economic reforms and after economic reforms. The following Table 5 shows the result of log linear model used for knowing the impact of economic reforms on growth of software firms: Table 5 Trends in Growth of Indian software industry (Compounded annual growth rate CAGR in Percentage) Phase Period TVSS ISEX DMSS Before liberalization 1985-1992 40.00 53.33 29.91 After liberalization 1993-2011 37.96 40.18 32.89 Entire period 1885-2011 43.87 48.67 36.10 ln = + t+ ---------------------------------------------------------------------------------(3.1) Where ln is the total values of software sales (TVSS) over period (t); Indian software exports (ISEX) and domestic software sale in India (DMSS). These variables are regressed on time variable for period before economic reforms and after economic reforms. is the intercept term; is the coeificient and is the error term. 3.2 Results Analysis and Discussions In the model (3.1) parameters and are linear. However, regressand is in the natural logarithm of Y variable and regressor is the time, which takes value 1, 2, 3, etc. In order to find out Compounded annual growth rate (CAGR), we took antilog of the estimated β 2 and subtracted 1 from it and multiplied it with 100. Then, we got CAGR for the three distinctive 9
phases. It can been seen in the Table 5 that before liberalization CAGR for total value of software export was 40 percent where as only software export to aboard countries was 53..33 percent and domestic software sales show almost 30 percentage growth. An interesting finding is that after the introduction of economic reforms, total value of software sales (domestic and abroad), and software export earnings got declined. However, software sale in the domestic market value rose by 3 percent during the period of liberalization from 33 to 36 percent. Domestic software sales of might have increased because of the penetration of computer use and internet use on large scale. Later, importance and value addition made by software programmes were recognized in the banking, production, administration, finance sector. For the entire period, TVSS, ISEX and DMSS rose at CAGR 44, 49 and 36 percent respectively. The speed of total software export value and overall software export is remarkable. 3.3Testing Parameter Stability of the Model: Chow Test We used time series data for the period 1985-2011. This type of data may show structural change in the relationship between the regressand Y and the regressor due to a policy change. India signed treaty in 1994 and before that it introduced the economic reforms in 1991. This policy change event may bring change in the growth of Indian software industry. Hence, the values of the parameters of the model do not remain the same through the entire time period. To find out a structural change, we divide the data for the period 1985-1992 (Before economic reforms period) and period 1993-2011(after economic reforms period). In fact, economic reforms were introduced in 1991 but to realize its impact we choose two year period as lag the after introduction of reforms, therefore, regression (2) starts from 1993. In addition to these two regressions, we also run the regression for the whole period (1985-2011). We run the following three regressions: Time period 1985-1992: ln = + t + ------------------------------------------------------- (1) Time period 1993-2011: ln = + t + ------------------------------------------------------ (2) Time period 1985-2011: ln = + t + -------------------------------------------------------- (3) 10
Regression (3) assumes that there is no difference between the two time periods and therefore this regression assumes that the intercept as well as the slope coefficients are same over the entire period: that is there is no structural change. If this is the fact then we assume that: and Regression (1) and (2) assume that the regressions in the two periods are different: it means that the intercept and the slope coefficients are different, the s represent the error terms. After running regressions numbers 1, 2, and 3; we use the results thereof for chow test. Restricted residual sum of squares of regressions 1 and 2 are added together then we got unrestricted residual sum of squares. Restricted residual sum of square is obtained from regression 3. After that the following chow test formula is used to test null hypothesis that regression 1 and 2 are statistically the same (in other way there is no structural change or break): / / ~, 1 2 2 -------------------------------------------------(4) F= 3.69 From the F table, we find that for 2 and 26 degree of freedom (df) the 1 percent critical F value is 5.53. Therefore, we do not reject the null hypothesis of parameter stability (i.e., no structural change) if computed value in an application does not exceed the critical F value obtained from the F table at chosen level of significance. Therefore, Chow test proves that there is no structural change in the total value of software export earnings in spite of economic reforms being implemented since 1991. 4. Structural Changes in the Indian Software Export Earning Regression In order to analyze the impact of economic reforms on the behavior of software earnings, we use dummy variable model. The differential variable 0 and 1 are used to denote the period before economic reforms and alter reforms respectively. To overcome the limitations of Chow Test; dummy variable regression is an appropriate because it carries certain advantages. It tells difference arises in the regression of two periods is due to the intercept 11
terms or the slope of coefficient. We use the data for period 1985-86 to 2010-11 on the variables total value added software export (international export and domestic) is regressed on the variable software export made by Indian IT-BPO firms and dummy variable. After converting these variables into natural logarithm (except dummy variable), unit root and cointegration test have been conducted. 4.1 Unit Root Test Time series data may contain non-stationary properties. If that series is non-stationary and it is regressed on the another time series, then outcome of regression results would be spurious in which R 2 value will be high and t test values will be also high. In such circumstances, nonstationary series can be converted into stationary by adapting stochastic process. Time series is a stationary if its mean, variance and auto-covariance (at various lag) remain the same no matter at what time we measure them; that is all them are constant. Such series will return to its mean and fluctuations around mean (variance) will depict constant amplitude. The following Random walk model (RWM) is used to find out whether series is stationary or not? Y t = + -1 1 --------------------------------------------------------------------(5) Where is white noise error term with mean 0 and variance, and series Y at time t is equal to its value at time t-1 plus a random shock. If 1 becomes a RWM (without drift. if p is in fact 1, we face the problem of non stationary. If however, ( 1 that is absolute value of p is less than one, then is can be shown that time series Y t is stationary. After testing unit root of series, we test the co-integration it any between them. 4.2 Unit Root Test of the Series Using Phillip-Perron Unit Root Tests The difference between ADF and PP test is that ADF tests adjust the DF test to take care of possible serial correlation I the error terms by adding the lag difference terms to regressand. However, in the PP test, nonparametric statistical methods is used to take care of serial correlation in the error terms of the without adding lagged difference terms. In the following Table 6, the computed value value is negative and should be more than the critical value. 12
In the present case it is almost equal to 5% critical value and having negative sign but not above it. Hence we conclude that these series are weakly stationary. Table 6 Unit Root Test Results Variables Test statistics 5% critical value Mackinnon p value for x (t) d.lntvs -2.796-3.00 0.0588 d.lnsex -2.966-3.00 0.0382 Note: d.lntvs is difference series of natural log of total value of software export (domestic and international) and d.lnsex is difference series of software export from India. 4.3 Co-integration In the time series analysis, if we regress one time series on another time series having nonstationary character that may produce a spurious regression results. There are number methods of testing co-integration. Co-integration means economic variables will be cointegrated if series under consideration have long term equilibrium. We use Engle-Granger or Augmented Engle-Granger (AEF) Test. We first regressed lntvs on lnsex and obtained the following regression: + lnsex t + dummy + -------------------------------------------------------------( 6) In the above regression lntvs and lnsex are individually non-stationary but there is a chance of spurious regression. However, after obtaining values of Error term from the above regression we can perform unit root test on residual by using the following regression. Δ = α +β ------------------------------------------------------------------------------------- (7) = (-3.00) R = 0.2910 d = 2.29 Where Δ is the residual obtained from regession (5) in the differtial form and t is time. β coefficient value of residual lagged 1, d is Durbin Watson autocorrelation test. 13
the Engle granger 1 percent critical value value is -2.5899, since computed ( t) value is exceed than negative value of this (-3.0000), hence we conclude that the residual from the regression of the above series (lntvs on lnsex are I(1) are stationary. Therefore, regression results obtained from the regression (5) are not spurious. Though, variables in the present regression are non-stationary. Thus the value 0.7748 is the elasticity value of lntvs. 4.4 Model and Interpretation of results Regression results are shown in the table 7. It can be seen that differential coefficient (denoted by dummy variable) is insignificant. However, the slope coefficient is significant at 1 percent. Hence, the regression of two periods is not different. On the contrary the impact of economic reforms on the total value added of software export earning is seen in the regression number (8). = + + + ----------------------------------------------------------------------(8) Where Y = Total software export value (export from India and sale in domestic market) is independent variable X= independent variable (software export from India) t = time; = error over time D = 1 for observation in (1985-1991) 0, otherwise (i.e., for observation in 1992-2011) In the Table 7 the R 2 value of regression is quite satisfactory and (t) values of the coefficients are good. There is no auto correlation problem in the regression is shown by the Durbin Watson test. Thus if the differential intercept D is statistically insignificant and slope coefficient are significant, we may accept the hypothesis that the two regression are concurrent. As it can be seen from the coefficient value of the intercept that there is a change in the two time period but that change is not statistically significant. Hence, the economic reforms have not made any strong impact on the earning of the software industry in India. 14
Table 7 Structural Changes in the Indian Software Export Earning Regression Using Dummy Variable Approach d.lntvs Coef. Std. Err. t P>t Number of obs. d.lnsex.7748328.0593795 13.05 0.000 25 R- squared=0.8863 dummy.037911.0242305 1.56 0.132 F= (2,22) 85.74 Prob > F (0.000) constant.0228622.0323735 0.71 0.487 Durbin-Watson d-statistic( 3, 25) = 1.838034 Note: d.lntvs is difference (0) series of natural log of total value of software export (domestic and international) and d.lnsex is difference (0) series of software export from India. 5. Conclusions We find that Indian IT exports was accounted for 0.33 per cent in 1985-86 of the total exports. Further, it increased to 1.29 per cent when new economic reforms were introduced in India. Subsequently, it is shot up to 34.39 percent by 2010-11. Presently, IT exports have occupied prime place in the composition of India s total exports. So far as the contribution of Indian software industry is concerned, its share into GDP of India has been consistently growing from 0.01 per cent in 1986-87 to 9.84 per cent in 2011-12. Among the various software products and services exporters in the world, India has captured market of 7.8 per cent in the total world market. However, in terms of extension and enlargement of market reach; India was exporting software products and services to 132 countries in 2002-03 which subsequently rose to 145 countries in 2010-11. In the ITES/BPO services, the share of Indian BPO was 80.18 per cent in 2007-08 which declined to 76 percent by 2009-10. This is due to American crisis and subsequent crises emerged in Europe. Under the category of BPO services, customer interaction, finance and accounting and medical transcription is the major heads from which Indian software firms earned near about 30 percent earning. These areas of services are treated as potential source of more revenue to Indian software firms. In addition to BPO services, Indian firms are 15
rendering engineering services whose share has increased from 14 per cent to 24 per cent during the same period. India has great future in exporting engineering services. To account the growth of Indian software industry during the economic reforms and to seek answer to a research question whether software industry has done well or not during the economic reforms period? For that, we use different econometric techniques: Log linear model, F test techniques and dummy variable regression model have been used. Results show that after the introduction of economic reforms; total value of software sales and software export earnings got declined. However, software sales in the domestic market rose by 3 percent during the economic reforms period. In addition to log linear model, Chow test is used to test stability of parameters, which proved that there is no structural change in the total value of software export earnings even though new economic reforms have been implemented. To overcome the limitations of Chow Test, dummy variable regression is an appropriate because it carries certain advantages. Besides that it also tells about difference arises in the regression of two periods is due to the intercept terms or the slope of a coefficient. Results appeared after running dummy variable regression shows that economic reforms have not made any strong impact on the export earning of the software industry in India. But it has created the favourable climate to grow these firms. 16
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