India's largest IT outsourcing company has been hit by two large contract cancellations from Wall Street banks in the latest sign that the sub-prime crisis is weighing on the world economy.

Tata Consultancy Services (TCS) said two of its ten largest clients had cancelled projects that were due to start this quarter.

India's largest private-sector employer did not say which customers were affected, but it is thought that they are Citibank and Merrill Lynch. The two US banks have taken a hit of more than $40 billion between them in the wake of the sub-prime crisis and could yet announce more writedowns.

India's IT industry is massively exposed to the West's financial sector, which is by far the largest user of its services.

Earlier this week, Kris Gopalakrishnan, the chief executive of Infosys, India's second-largest software exporter, also said that European and US banks are cutting or freezing IT budgets this year and are already planning to move more work to cheaper countries to cut costs.

Such moves are likely to herald further job cuts in the City. Wages for computer programmers have spiralled upwards in London in recent years amid fierce competition among banks and a dearth of domestic talent. The trend helped fuel a 6 per cent rise in global spending on IT by banks last year, to an estimated £170 billion. Lower-skilled call centre work may also be affected.

Mr Gopalakrishnan said: "Lots of budgets that are being finalised are flat; some are down … the declines are in single digits".

Spending decisions are being delayed as firms across all sectors tighten spending and decide whether they can make do without upgrading the technology that underpins their businesses, he added. Those banks where leading executives have been forced to step down in the wake of the US sub-prime crisis are being especially indecisive.

Financial companies accounted for about a third of Infosys's revenues of $3 billion last year.

TCS relies on its ten largest clients for nearly a third of its revenues and on the US for more than half its earnings. It did not say by how much its profits would be affected by the latest project cancellations.

In January the company said that it remained optimistic over the outlook, largely because it thought Western companies would spend more on low-margin outsourcing contracts to cut costs.

The banking slowdown comes at a bad time for the Indian IT industry, which is already fighting the effects of the rupee's sharp appreciation and wage inflation expected to run at between 12 per cent and 15 per cent this year.

The sector will also soon face an estimated $1 billion-plus bill when a holiday on export taxes on software lapses, a move that will increase Infosys's effective tax rate to about 22 per cent from about 15 per cent.

Fears that the shockwaves from the US sub-prime crisis are set to hit India's shores have been mounting since the new year. In recent weeks, IBM and TCS have both axed hundreds of underperforming workers in India, while TCS also cut bonus payouts to workers for the first time in its history.

In January, the four largest Indian IT houses – TCS, Infosys, Wipro and HCL Technologies – posted average sales growth for the third quarter of just over 21 per cent, sharply down from more than 50 per cent a year earlier, the point at which the rupee's rise began in earnest.

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive