IT growth faces AI squeeze in Q2FY27 as pricing pressure mounts

Reports coming in for today mention that Indian IT services firms are likely to report another muted quarter in Q2FY27 as AI-led deflation and pricing pressure weigh on the existing business, while new AI topline is still not large enough to offset the impact, Kotak Institutional Equities stated. The brokerage anticipates large IT firms to stay subdued, with mid-tier firms such as Persistent Systems, Coforge and Mphasis likely to deliver stronger expansion.

Large IT firms likely to see muted expansion

Kotak anticipates tier-1 IT firms to report weak expansion despite Q2 typically being a seasonally firm quarter. AI-led deflation and weaker macro conditions are anticipated to weigh on expansion.

Among large IT firms, HCLTech is anticipated to lead with 2 percent sequential organic expansion, followed by Infosys at 1.1 percent and TCS at 0.5 percent. Tech Mahindra is anticipated to perform better among the hybrid firms, with 1.6 percent sequential expansion.

Kotak anticipates Wipro to see a 1 percent sequential topline slide, while LTIMindtree is anticipated to grow 1 percent.

Mid-tier firms keep outperform

The expansion picture is anticipated to be stronger among mid-tier firms.

Kotak anticipates Persistent Systems to report 7 percent sequential expansion, helped by the ramp-up of a mega deal. Coforge is anticipated to grow 4.5 percent, while Mphasis is anticipated to grow 3.5 percent.

The brokerage stated challengers are continuing to gain market share through stronger execution, while larger incumbents are largely focused on defending their existing topline base.

Kotak stated the competitive gap between large vendors has narrowed after several years in which some firms benefited from execution issues at rivals. With most large vendors now operating more efficiently, competitive pressure for deals has increased.

AI is putting pressure on the existing business

A key concern for the sector is that AI is beginning to change the economics of traditional IT services.

Kotak anticipates gross deflation of around 7 percent and net deflation of 3.5 percent for IT firms. Clients are increasingly seeking productivity savings from AI and are pushing for those savings to be reflected in contract pricing.

At the same time, new AI-related topline opportunities are still at an early stage and are not large enough to fully offset the deflation in the existing business.

Deal wins may not translate into expansion

Large deal activity stays healthy, but Kotak anticipates a significant difference between firms in terms of deal wins and their ability to convert those wins into topline.

HCLTech, Persistent Systems, Coforge and TCS are anticipated to report firm deal total contract values, while Infosys, LTIMindtree and Wipro are likely to see weaker deal momentum.

That stated, Kotak cautioned that winning a large deal no longer automatically means stronger expansion. Clients are increasingly building anticipated AI-fuelled productivity upside into contracts, putting pressure on pricing.

Margins stable, but pressure building

Margins are anticipated to stay broadly stable for now, helped by the indian rupee's depreciation.

The indian rupee softened 0.8 percent sequentially and 8.4 percent year-on-year during the quarter, which should provide some backing to margins and earnings. That stated, the benefit may not immediately flow through to net earnings because of firms' hedging positions.

Kotak anticipates Tech Mahindra, LTIMindtree, Coforge and Hexaware to report meaningful forex losses during the quarter.

The brokerage anticipates large firms to report stable to marginally softer margins year-on-year, while margins for mid-tier firms should stay stable to improve.