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That is not my observation. It is also not clear what you mean with "get upgraded to Hangouts". I use Hangouts extensively, but I use also Gajim as client for my Google account and still I'm able to add XMPP contacts from non Google XMPP servers to my Google roster.

So I basically can confirm that Google did not turn off XMPP federation for their XMPP service. It appears that there is simply no UI to add users from federated servers over hangouts, but it works with standard XMPP clients. So you could say that "Google dropped support for XMPP in their UIs". But you can still use your Google account as plain XMPP service (which doesn't mean that I would encourage it or think that it's a good idea).

But I can't rule out that e.g. some servers can't federate with Google, for example because of policy restrictions.

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