Software and information technology services are already a bright spot in India’s economy, yet they could be a lot brighter. Employing 280,000 skilled and semiskilled workers, the industry does enjoy favorable tax treatment, but it is encumbered by government red tape and by a clunky telecommunications infrastructure. Overhauling both could help catapult the business to world-class status by 2008, McKinsey concluded in a study for India’s National Association of Software and Service Companies (Exhibit 1). By that year, software and IT services could create 2.2 million jobs and attract up to $5 billion in foreign direct investment—more than the entire Indian economy attracted in 1998. Of the $87 billion in revenues the industry might generate by 2008 (up from $3.3 billion in 1998), $50 billion would come from exports. The industry’s market capitalization could be expected to rise tenfold, to $225 billion.

Markets are opening up in four broad areas: software products, electronic business, IT-enabled services (for instance, remote processing), and basic IT services themselves, which is the source of almost all of India’s current success. IT services are expected to remain the bulwark of the industry, thanks to the competitive advantage that India has in people and vendor...