India: Targeting a Status of the Global IT Super-Power

March 2001

India: Targeting a Status of the Global IT Super-Power

Indian Government Software Policies and Their Benefits

Executive Summary

Introduction

The Information and Communication Technology (ICT) revolution opens up new prospects for mankind.

The third millennium witnesses a new role that developing countries and nations with transitional economies may play in the world economic landscape. Most countries today are becoming aware of the advantages that ICT is bringing when given top priority.

India’s unique experience in Information Technology (IT) is definitely worth studying. Within a short period of time, this vast and rather poor developing country has managed to build a powerful IT industry with a dramatically growing software export sector. It has become possible thanks to Indian Government policies that have strongly supported IT development, as well as to the activities of Indian entrepreneurs, and due to certain advantages that this country enjoys.

ICT Global Market

Survey

The worldwide ICT market surpassed the $2 trillion mark in 1999, even as growth continued at a 9%

rate (International Data Corporation and Digital Planet 2000 surveys). In 2003 – 2004, it will smash through an estimated $3 trillion threshold. North America remains the world’s largest ICT regional market with $796 billion in 1999 spending. The top ten nations represent 80 percent of the global ICT market.

IT Software and Services Market

According to the McKinsey Global Institute report, the IT software and services market is currently estimated at $400-500 billion and is steadily growing at 10-12% annually, with the software sector growing at 14%, and the IT services sector – at 10%. The contribution of the IT software and services sectors to the surging IT industry is invariably increasing compared to that of hardware: software products and IT services amount to 60 – 80% of the total IT product costs.

The information technology boom and an ever growing demand for IT services have caused a number of problems in developed industrial countries. The rising software development costs and the severe shortfall of domestic IT professionals are at the top of the list. Western companies seeking new labor markets and targeting cost avoidance contribute to investing into less-developed economies.

Globalization and Vision for Developing Countries

Given the surge in telecommunications and Internet, along with the standardization of software development, the technologies and skills within software production have become sufficiently stable to allow outsourcing software programming and engineering services beyond national boundaries, i.e.

offshore software development. Globalization of the labor market for professional resources has

facilitated a breakthrough in the economies of less developed nations and enabled developing countries

to enter the world postindustrial market.

IT Software and Services Industry

IT software and services is a specific industry with considerable labor costs and intellectual investment that produces a unique “virtual” product. Within the overall set of technologies that make up IT, software production is less capital-intensive and more labor-intensive, which offers favorable opportunities for developing countries and nations with transitional economies to become integrated into the global ICT market.

The recent decades have witnessed high growth rates in the software industries of such developing countries as India, China, Brazil, Mexico, Singapore, Hong Kong, Taiwan, South Korea and the Philippines. India stands apart in that list as its software history is one of the longest-established, and, secondly, because for the last 30 years the Indian government has pursued a well-defined IT software and services policy.

Indian Government Software Policies

Government Interventions in IT Industry

In all countries worldwide, a state is the largest consumer of IT products and services. State demand for IT products and services has a strong impact on the development of the national IT industry. By defining and enforcing the state economic, legislative, and tax policies, the government intervenes to influence the development of national industries. In this process, it can have three major roles – regulator, promoter and producer.

Indian Government Incentives to Advance IT Software and Services The Indian software industry faces a number of development constraints, which include:

! Low level of the country’s economic and social development

! Limited access to finance

! Limited access to emerging technologies

! Shortage of skilled labor

! Low level of research and development

! Limited access to telecommunications and other infrastructure

! Limited access to IT markets and to information on these markets

! Low demand in the domestic market

! High piracy in the domestic market

In response to these constraints, the Indian government has actively intervened in software production to minimize their damaging effect. The current surge in India’s software industry is the result of the government policies aimed at encouraging high technology export in general, and IT software and services export in particular.

In 1998, the Indian government set up a National Task Force on Information Technology and Software Development (IT Task Force) to define the draft of a National Informatics Policy. The IT Task Force has submitted the Information Technology Action Plan for the next 10 years (till the year 2008) which is aimed at accomplishing the following three basic objectives:

! Info-Infrastructure Drive: Accelerate the drive for setting up a world class Info

Infrastructure.

! Target ITEX – 50: Target for a $50 billion annual export of India’s IT Software and IT Services.

! IT for all by 2008: Accelerate the process of IT penetration into every walk of economic and social life.

Indian IT Industry: Indicators and Statistics

Growth Rates

The government incentives and liberalization policies relating to the IT companies have resulted in an impressive boost in the IT industry revenues. In the past ten years (1991–2000), the Indian IT industry has recorded an average annual revenue growth of about 50%. In 1999–2000, the industry was estimated to have earned revenues of $8.6 billion, with the share of software amounting to $5.7 billion.

In the first half of the 2000–2001 fiscal year, the domestic IT software and services market was up by 48%, while the total industry growth rate accounted for 58%.

Software Exports

The Indian software export industry continues to show dramatic growth rates. Over the past two decades (1980–2000), a compounded annual growth rate was as high as 40%. According to the Indian National Association of Software and Services Companies (NASSCOM) report, in 1999-2000, a total export of $4 billion was achieved, and it is expected that during 2000-2001, software exports will be worth $6.24 billion.

Labor Productivity

When working at the clients’ sites overseas, Indian software developers achieve productivity levels as high as those of their Western counterparts and sometimes higher by 20-50%. Within India, productivity figures vary quite widely among different companies, but on average they amount to 90-50% of those of Western companies. However, a lower labor productivity is partly compensated by longer working hours: Indian software companies work a 45-hour week, while those in the West work a 35- or 40-hour week.

Quality of IT Software and Services

The efforts of the government and entrepreneurs aimed at improving the quality of IT software and services have resulted in worldwide recognition of the Indian IT industry. By April 1, 2000, the number of quality certified companies with ISO 9000 and SEI CMM Level 3 (and higher) certificates amounted to 210, while another 70 were in the process of acquiring certification. In January 2001, 44 software companies around the globe had the unique distinction of an SEI CMM Level 5 certification, and 24 of them were Indian.

Investment

In 1996-2000, venture capital in the Indian IT industry grew from $20 million to $370 million. Currently,

28 venture capital funds are registered in India. According to NASSCOM, in 2000-2001, the venture

capital growth rate is expected to reach 100%, with the total investment capital going up to $700 million.

Telecommunications and Internet

From the mid-1980s, the Indian government has given priority to the development and funding of the telecommunications infrastructure. State investment in international telecommunications alone went up from $150 million in 1985-1990 to $200 million in 1990-1995. From 1990, the overall government spending on international and domestic communications grew by 15% annually. Until recently, India possessed international telecommunications channels with a total capacity of 396 Mbit per second.

Statistics show that by March 31, 2000, the number of Internet users in India was 3,2 million people.

Software Technology Parks of India

At present, there are 19 Software Technology Parks (STPs) controlled by the Ministry of Information Technology. They all form an autonomous unity called Software Technology Parks of India (STPI). 60%

of the overall software exports from India is attributed to the STPI.

The basic characteristics of the Indian Software Technology Parks (STPs), Export Processing Zones (EPZs), and Export-Oriented Units (EOUs) are:

! Simplified, duty-free export-import procedures

! A quick, “single window” for all bureaucratic dealings

! Subsidies on sales and excise tax

! A five-year corporate tax exemption for STPs and a10-year tax exemption for EPZs and EOUs

! Simplified foreign exchange operations

! Permission to establish companies with 100% foreign venture capital

! Developed telecommunications infrastructure, access to international telecommunications links

! Availability of office space and preferential terms for constructing new business premises

! Subsidies for and reduced rates of space rent and municipal services charges (electricity, water, etc.)

! Well-developed infrastructure facilities, etc.

Human Resource Development

According to NASSCOM, as on March 31, 2000, the IT software professionals employed stood at 340,000, with engineering graduates amounting to 80%. Currently, Indian universities train some 68,000 IT professionals a year. Within a relatively short period of time, India has managed to reform the higher education system in general, and the IT training in particular. The country has developed a comprehensive policy for human resource development that meets the world standards.

Property Rights in Software and Piracy

Thanks to the Indian government and NASSCOM policies aimed at protecting property rights in software,

the share of the copyright software is steadily increasing. According to NASSCOM, in 1986, pirated

software in the Indian market amounted to 98%, while by the year 1999, the share of copyright

software had grown up to 40%.

Vision for IT Software and Services by the Year 2008

According to the NASSCOM-McKinsey Global Institute study report and the Indian IT Ministry estimates, by the year 2008, the IT software and services sector will play a key role in the Indian economy, provided the current trends and the favorable political and economic climate are retained. By 2008,

! The IT software and services sector will earn revenues of $87 billion

! The overall IT industry revenues will go up to $140 billion

! The IT software and services market capitalization will exceed $225 billion

! Over ten multinational corporations in India will have annual revenues of over $2 billion each

! IT software and services will contribute to over 7.5% of the overall GDP growth

! The software products market will amount to around $18 billion, with the domestic product market as high as $10 billion

! Starting from 2001, the IT software and services exports are expected to double every year and to reach an estimated high of $50 billion by 2008

! The software and services sector will create employment for over 2.2 million professionals

! The software and services sector is expected to attract foreign direct investment of $4 - $5 billion, more than the overall foreign direct investment in all Indian industries in 1998

Indian IT Software and Services Export Industry

The Indian IT software and services industry is distinctly export-oriented. India has refuted the common belief that IT exports are impossible without a strong national IT industry and a well-developed domestic market.

Prerequisites of IT Software and Services Export Growth

Focus on export orientation in India’s software industry has derived from a number of factors, namely:

! A high percentage of the English speaking population

! A low average standard of living

! A 2000-year-long history of the national mathematics culture

India’s success in shaping its software exports development can be attributed, to a great extent, to the efforts of:

! The government that has concern about and vision for this way of the national development

! The state technocratic institutions that support and patronize the industry advancement

! NASSCOM – a powerful organization that unites Indian software companies

! A mighty Indian Diaspora in many countries worldwide, particularly in the USA

Importers of Indian Software and IT Services

Before the late 1980s, India’s largest software importer was the USA. Now the US market continues to

dominate Indian software exports. However, since 1990, India has been exporting software to other

countries as well. As per a NASSCOM survey, in 1999-2000, India exported software and IT services to

95 countries around the world, with almost 62% of exports to North America (the USA and Canada),

23.5% - to Europe, 3.5% - to Japan, 5% - to other Asian countries, 1.5% - to Australia and New

Zealand, and 4.5% - to the rest of the world.

Concentration of Production

The Indian IT industry production is heavily concentrated. According to a NASSCOM survey, in 1999- 2000, out of 1250 Indian companies engaged in the business of software exports:

! 37 companies exported more than $2.3 million of software

! 60 companies exported more than $1.15 million of software

! 6 major companies produced over 40% of the overall Indian software exports

! The top twenty software exporters accounted for 70% of the software exports revenues

Areas of Expertise: From Y2K To Solutions In Other Fields

As per a NASSCOM survey, in 1999-2000, the Y2K (the Year 2000 problem) solutions yielded about 12%

of the Indian overall software exports revenues and amounted to $480 million. During 1996-1999, the Y2K solutions earned export revenues of $2,5 billion. However, their far more valuable asset to the national IT industry was the acquired experience which paved the way to further partnerships with foreign customers. The Indian software industry has been experiencing tangible transformations that have resulted in extending its operation to cover new areas relating to e-commerce and IT enabled services, as well as offering new IT services to more customers.

Export Output

In developing countries and nations with transitional economies, IT software and services exports have been characterized by the following three strategies – export of labor (“body shopping”), export of software services (offshore software development), and export of software products (in the form of packages), with each new strategy marking a more advanced level of the national IT industry. Currently, 50% of India’s software export development takes place at the client’s site overseas (“onsite”), about 45% accounts to offshore software development, and just under 5% of exports comes from “packages”.

80% of export contracts by Indian companies is coding, testing and product maintenance, while analysis and design that require higher levels of skill and experience are performed by Western partners.

However, there have recently been signs of change. With the trend towards more high-technology projects, the number of companies capable of implementing a full life cycle development is increasing.

The quantitative and qualitative growth of Indian software firms has led to favorable opportunities for developing

their own products and new technologies and for promoting them in the global market.

Locational Concentration of Indian Software Companies

Software companies are mainly located around a few major Indian cities. The IT industry started in Mumbai (Bombay), which remained the national software development center till the mid-1980s. In the late 1980s, IT firms started to locate in Bangalore, which has grown ever since and, despite many differences with its California counterpart, has now come to be viewed as India’s “Silicon Plateau” or

“Silicon Valley”. In 1999-200, about 400 companies located in Bangalore exported IT software and

services worth over $1.1 billion to the world market.

Indian Software Export Industry (Conclusions)

Within a relatively short period of time, India - a vast and rather poor Third World country - has become an important player in the global IT market. Export orientation of India’s IT industry and, in particular, a surge in offshore software development have enabled the country to get access to emerging technologies and world experience in organizing software development.

Basis For India’s IT Industry Rapid Growth

The rapid growth of India’s IT industry has become possible due to certain regional advantages the country has enjoyed, as well as to the following key factors:

! Successful enterprise tactics.

! Successful national strategy of the Government.

! National vision: India’s success as a Third World IT colossus has resulted from a thirty-year dream of India’s businessmen and statesmen which was carried forward by the national IT talent.

The Indian government has intervened widely to accelerate the development of the Indian software industry. Areas of the government intervention are:

! Administrative Regulation

! Removing licensing for IT industry

! Simplification of registration procedures for IT software and services companies

! Establishing state structures to stimulate the growth if the IT industry.

Export-Import Policies

! Export Incentives:

# Introducing tax allowance, a special status of export zones and units – EPZs, EPOs and, in particular, STPs - with favorable, IT friendly environment for the industry development.

! Import Liberalization

# Gradual reduction of customs duties on import of IT software from 114% to nil in accordance with the 1999 Government Notification.

# Zero import duty on books, magazines, periodicals on CD-ROM under the 1998 Customs Notification.

# Stage-by-stage reduction of import duty on computers and peripherals.

# Zero import duty on computers and peripherals that after two years of import and use are donated to public institutions, hospitals, schools and government establishments.

# Liberalization of Internet “e-commerce”, etc.

Finance and Investment

Stimulating the supply of private and foreign capital funding to the software sector, telecommunications infrastructure and IT education and training:

! Granting tax benefits for software companies; special favorable conditions for joint ventures and private educational institutions

! Introducing schemes of preferential crediting

! Introducing schemes of insurance against risk

! Allowing for IT companies with 100% foreign venture capital

! Allowing for 100% foreign capital share in e-commerce

! Granting tax benefits for those buying shares of large foreign companies

! Granting tax benefits for venture capital funds that invest in software companies Education and Training

! Reforming the system of IT education at secondary and higher educational institutions

! Introducing certification schemes for skills

! Stimulating standardization of education and accreditation schemes for educational institutions

! Encouraging young people to major in Computer Science (a developed system of subsidies, tax benefits, and other incentives)

! Stimulating private and foreign investments in IT education and training

! Providing government support for and financing of educational institutions Telecommunications Infrastructure

! Encouraging private and foreign capital investments in telecommunications development

! Privatizing state telecommunications companies

! Eliminating the state monopoly on various types of services

! Providing government support for and financing of telecommunications development Stimulating Research and Development in Emerging Technologies

! Financing and crediting high-tech research and industrial projects

! Encouraging standardization and international certification (ISO 9000, SEI CMM)

! Introducing the system of state orders that provides incentive to development and implementation of high-tech production and management processes

Intellectual Property Rights Protection

! Improving the legislation and toughening punishment measures for intellectual property rights infringement

! Provisioning economic incentives to using licensed products (for instance, zero import duty on IT software)

Government Incentives to Give Further Impetus to Software Industry Further Government interventions went along the following lines:

! Introducing additional financial measures to regulate the activities of the IT companies;

! Providing support for private IT education, and private IT research and development;

! Ensuring industry oriented personnel training within the state education system;

! Developing infrastructure and reducing its costs;

! Expanding state marketing to promote IT companies in the global market;

! Pursuing more aggressive anti-piracy policies;

! Implementing the strategy of state contracts;

! Speeding up and simplifying red-tape procedures; and others.

India’s Experience and Offshore Software Development in Russia

Russia possesses a number of favorable prerequisites for building a competitive IT software and services export industry. Offshore software development provides a unique opportunity for the national IT industry in Russia to grow because it combines economic benefits of science-intensive exports and indirect imports of emerging high-tech expertise which, in the long run, will enable the Russian software industry to evolve to the world standards.

The Russian IT industry produces offshore development services for less than $100 million which is approximately the same as India’s offshore software development revenue10 years ago. According to the McKinsey Global Institute report, the annual growth of offshore software development in Russia amounts to 50-60% and it is estimated to remain at the same level in the near future. However, Russia is entering a well developed global IT offshore market where competition is really tough. Defining the government policies aimed at encouraging IT software and services exports is crucial for Russia’s IT industry development and for turning the country into an important player in the information and communication technology market.

Requirements for IT Offshore Success

Successful IT offshore development relies on the following key requirements:

! Well-defined legal basis for IT export/import

! Favorable business climate and business culture

! Political and economic stability

! Pool of IT professionals

! Developed telecommunications infrastructure and access to reliable and cost- effective communication links

! English language fluency

! Professional expertise and sound business reputation

! Established system of certification in ISO 9000/ SEI CMM standards

Prerequisites of IT Offshore Growth in Russia

The factors that contribute to the growth of IT software and services exports in Russia are:

! Technical skills and education; a pool of top-notch professionals

! Experience with complex projects

! High labor productivity in the IT industry

! Availability of IT talent

! European/Western culture

! Location and time zones

! Low labor costs

! Availability of infrastructure

Constraints Impeding IT Industry Development in Russia

Despite the fact that Russia’s IT industry is growing fast, there are a number of constraints that lower the country’s competitiveness in the global IT offshore market. They are:

! Weaknesses of the legal system

! Unfavorable business climate and lack of business culture

! Political instability

! Limited capital market

! Shortcomings in IT education and training

! Inadequate IT infrastructure

! Limited experience in management of offshore software development processes

! Lack of ISO 9000/ SEI CMM certification organizations

! Language barrier

! Cultural differences

! Visa restrictions

! Marketing capability, and others

Areas for Government Intervention in IT Industry Development

Given the factors that contribute to Russia’s IT software and services development, there is every reason to believe that Russia will soon number itself among the world’s leading offshore development providers.

IT offshore development will enable the country to substitute high-tech export of IT software and services for export of non-reproducible raw material resources. However, the IT industry is facing a number of challenges which are to be met both by IT companies and by the government.

There are three major areas for government intervention in the IT industry:

! Demand (IT users)

! Supply (IT suppliers)

! Environment and Infrastructure (bridging demand and supply)

India’s experience provides clear evidence of the fact that government support is crucial for building a

strong IT software and services industry. India has given priority to export-oriented IT development, IT-

friendly regulations in investment, taxation, administrative management, and other policies. Apart from

that, India has established Export Processing Zones, Export-Oriented Units, and Software Technology

Parks. Russia has a unique opportunity to make use of the huge experience accumulated by Indian

entrepreneurs and the Indian government. It will enable Russia to consolidate on its current gains in the

global IT market and to accelerate the development of the domestic IT market.