AI-led deflation, weak demand to keep IT sector growth muted in Q2FY27; Mid-tier firms may post healthy gains: Report

NEW DELHI: The Indian IT sector is expected to remain under pressure in Q2FY27 amid weak demand and AI-driven pricing headwinds, with Tier-1 companies likely to see only modest sequential growth of 0-2 per cent, while mid-tier firms are projected to post moderate-to-healthy growth, as per a report by Kotak Institutional Equities.

The report noted the country’s IT sector reported a mixed Q1FY27 on the back of geopolitical tensions, macro uncertainty and client- and vertical-specific challenges dampening demand and delaying deal closures and project ramp-ups.

“Revenue growth performance was mixed. Firms with healthy large deal rampups grew well,” Kotak noted, adding companies facing client-specific demand headwinds and pricing pressures were impacted.

Apart from this, consistent weakness in discretionary spending and delays driven by high macroeconomic uncertainty weighed on guidance with multiple IT firms slashing organic growth guidance. However, despite a challenging environment, IT firms continued to secure large deals across key themes, including vendor consolidation, digital transformation, legacy modernisation, cost-driven outsourcing and GCC establishment.

At the same time, AI-led deflationary pressures are beginning to weigh on the industry. Productivity gains from GenAI adoption are reducing effort requirements in time-and-material (T&M) contracts and increasing pricing pressure on fixed-price engagements.

As per Kotak, the impact is already evident in lower spending and volumes in software development projects, alongside heightened pricing pressure in managed services deals. “These impact topline growth for the industry. The headwinds are largely borne by incumbents, i.e., Tier-1 IT,” Kotak noted, highlighting Mid-tier firms have been able to offset these pressures through share gains and new wins.

While profitability remains resilient, it is increasingly reliant on aggressive cost controls. Furthermore, companies are offsetting incremental pressure through rupee depreciation and stringent cost measures, including layoffs, delayed or lower wage hikes and reduced variable pay.

Revenue growth is strong in AI-related businesses. “However, the effect of deflation in the base business will more than offset tailwinds from new AI use cases in the near-to-medium term,” the report noted.

Overall, geopolitical tensions are likely to weigh on Q2FY27, easing macroeconomic uncertainty may reduce deal delays. Tier-1 IT companies are expected to post sequential revenue growth of around 0-2 per cent, while mid-tier firms are likely to deliver moderate-to-healthy growth in Q2FY27. “We expect moderate-to-healthy growth in other midtiers,” it said. (ANI)