As if having China encroaching on them weren't enough, the powerhouses of Indian IT outsourcing are feeling the impact of the global economic crisis.

Conventional wisdom, including that espoused by yours truly, held that outsourcing shops and their ilk (including consultants) could prosper in both up-markets and down. When times are good, and business is booming, we figured, the enterprise would need to expand capacity at rates precluding internal staffing and training... a ripe environment for outsourcers. And in bad times, those same enterprises would be fearful of bringing on new hires, and would select a resource easier to throttle back down quickly without the layoffs... again, a situation tailor-made for outsourcing.

But either we were wrong or this cycle transcends the common motivations... Wipro and Infosys are already scaling back, hurt by early collapses in the financial sector which heavily fueled their earlier growth according to this CIO.com article (aside: if you want to see the sad state of online 'journalism' today, Google "offshore outsourcing recession." That's right... all but one of the front page links is to that same article, republished mindlessly on a half-dozen industry sites, probably trying to suck the same advertisers dry at every turn). Satyam and Tata have also been down, not a very convincing display of resilience in an industry touted to be recession proof. More after the jump.

The CIO (or whoever) article cited above blames both the preponderance of financial services clients and the infatuation with headcount reduction as a primary motivation for outsourcing among clients. The author points out, quite correctly, that reduced headcount may imply but hardly guarantees reduced costs, and that businesses which have entered into outsourcing agreements without running their bottom-line numbers realistically may not be realizing much overall benefit from the arrangement. While that's true, it was true before the economy went south, and in any event the supposed benefit of downturns is that it forces the market to get real about what are and are not effective business practices. There is no reason that outsourcing should not, in many instances, continue to come out as the winner in those analyses, and so in my mind that doesn't factor into the hit.

What does, and what I feel is underplayed right now, is fear. Businesses aren't just holding back on outsourcing; they're holding back on everything. The fact that the credit markets are hardest hit has something to do with this... no one is able to finance any significant projects. But it's not clear that they would with the markets in turmoil anyway. I see quite a lot of advice on restructuring and revamping IT operations into leaner, meaner machines, but so far I have not seen a lot of action. I think leaders are frozen; uncertainty is shutting down the good and the bad initiatives alike.

This has global import, of course, not simply for Indian offshoring, but the good news is that it's unlikely to last. People recover, businesses realize they are going to have to operate in these conditions for the foreseeable future. Rational decisions will be made once again.

But the outlook for off-shoring may still be dim. With an increasingly protectionist-sounding Obama administration warming up for the mound and an overwhelmingly Democratic Congress taking the field behind it, offshoring operations may find themselves fighting an uphill battle to win back the business that is disappearing now.