Engaging India is a weekly online column analysing the issues, trends and forces behind the business and politics shaping India and its impact on the world, which appears on FT.com India, a dedicated online section on India. Engaging India appears every Thursday morning exclusively on FT.com India and is written by Jo Johnson, the Financial Times’ South Asia bureau chief; Amy Yee, New Delhi correspondent; and Joe Leahy, Mumbai correspondent.

Last week, Royal Philips Electronics embarked on a path that has become increasingly common among multinationals: it began offloading its ‘captive’ business process outsourcing centres, in this case to India’s Infosys Technologies.

The $250m deal, in which Infosys will take over Philips’ finance and accounting units in India and elsewhere, follows similar moves by Citigroup and General Electric, which in recent years have also spun off their captive back office operations in India.

The trend is confirmation that third parties, such as Infosys, India’s second-largest computer services operator, are better at outsourcing than groups like Philips, whose core business is branded consumer gadgets.

It should be no surprise then that if multinationals are finding it economically unattractive to run their own offshore centres, the situation will be much worse for smaller outfits.

Thus comments by Munjal Shah, who made headlines recently when he said on his blog that his Silicon Valley image search start-up, Like.com, was shutting its Bangalore operation, should be kept in context.

In the blog, Mr Shah said the market dynamics in Bangalore meant he would shortly have had to increase the pay of one of his Indian engineers to 75 per cent of the equivalent US wage, erasing any benefit from outsourcing.

It was tempting to extrapolate Mr Shah’s predicament to the entire Indian information technology industry. If the wage hikes at Like.com were any indication, then the survival of the entire sector must be in jeopardy.

As convincing as this might at first sound, it is at best an exaggeration. If Indian outsourcing is uncompetitive, why is the industry growing at such dizzying rates? Last fiscal year alone, revenues in the sector grew 30.7 per cent, according to its representative body, the National Association of Software and Services Companies.

“Yes, there is some reverse offshoring; however, this is far exceeded by the continued growth in offshoring,” says Hilary Robertson, offshore development officer with Xansa, the UK outsourcing firm.

No one disputes that wage inflation is an issue in India. But evidence indicates the situation is not yet as critical as the headlines might suggest.

Chetan Ahya, economist with Morgan Stanley in Mumbai, looked at wages as a percentage of total cost of sales for companies in the Bombay Stock Exchange 200 index and found the ratio had remained stable at about 8.5-9.5 per cent for the past seven years.

“Even if growth in real wages per employee … may be rising about 6-10 per cent depending on the sector, strong productivity growth is probably offsetting this wage growth,” the report said.

This is borne out by the technology companies themselves. In the first quarter of this fiscal year ending in June, most reported 10-15 per cent wage inflation, resulting in pressure on margins of about 200 basis points.

But in each case, firms offset this margin pressure through measures such as moving more work to India from high-cost onshore locations near clients in developed markets, or by hiring more science rather than engineering graduates. Science graduates’ starting salaries tend to be lower than those with engineering degrees.

The wage increases are also coming off relatively low base numbers. According to Nasscom, annual starting salaries in India are still about $10,000, a fraction of those in the US. Wage inflation in India, which averaged 15 per cent last year, was still lower in absolute terms than the salary increase of a US worker, who received an increment of about 3 per cent a year on a much bigger salary.

Salaries have risen quickly for more experienced Indian engineers. But within the large outsourcing companies, even those employees in greatest demand – those with six or seven years’ experience – are paid about half what they might receive in the US.

The situation is different for captive offshore units, however, particularly those whose parent companies operate in highly specialized fields such as software product development. Because they are effectively servicing one ‘client’ – their parent company in the US or Europe – captive units do not have the flexibility of a third-party outsourcer.

For instance, during quiet periods when their parent is not sending over much work, they suffer from lower utilization rates, a measure of whether they are working at full capacity. A third-party outsourcer can simply take on more work from other sources to fill these gaps.

Foreign product development start-ups also tend to hire the best new graduates or the most experienced or specialized engineers – in effect, the most expensive people on the market.

Mr Shah in his blog says as much. After all, he needs the best brains if he is going to develop innovative products. Process-oriented third-party outsourcers do not face this pressure.

What seems certain is that there will be many more foreign companies with small captive operations that will follow Like.com’s example and shut up shop in India.

Gowri Shankar Subramanian, chief executive officer of Aspire Systems, an Indian outsourcing firm that helps software companies build new products, says he has had several offers to take over captive units.

“We’re beginning to find a lot of movement of those kinds of companies wanting to exit and we think that will only accelerate in the next couple of years,” says Mr Subramanian.

Whether this will spread beyond captive operations to Indian third-party outsourcers, only time will tell. But it seems a long way off yet.