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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.
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.
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 start-
ups, 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.
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.
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.
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.
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
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
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:
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.
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 β2 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.
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:
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 un-
restricted 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.
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 co-
integration test have been conducted.
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 R2 value will be high and t test values will be also high. In such circumstances, non-
stationary 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?
Yt = + -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 Yt 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.
4.3 Co-integration
In the time series analysis, if we regress one time series on another time series having non-
stationary character that may produce a spurious regression results. There are number
methods of testing co-integration. Co-integration means economic variables will be co-
integrated 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:
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.
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
In the Table 7 the R2 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
Number of
d.lntvs Coef. Std. Err. t P>t
obs.
dummy .037911 .0242305 1.56 0.132 F= (2,22) 85.74 Prob > F (0.000)
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.
16
References
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Bhatnagar, S. (2006) , ‘India’s Software Industry’ , Technology, Adoption And Export: How
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Hill Publishing Company Limited, New Delhi, Pp. 396-450.
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Communication and Information Technology, New Delhi.
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World Bank (2000), World Development Report 1999-2000, Entering The 21st Century.
17