AI deflation, weak demand to keep large IT growth muted in Q2FY27; mid-tier to outperform: Kotak
Kotak report predicts muted growth for large IT firms due to AI-led deflation and weak demand, while mid-tier players are set to outperform.
LABEL: FOCUS: IT sector growth Q2FY27 LABEL: SEO_TITLE: AI Deflation to Hit Large IT Growth in Q2FY27 LABEL: SEO_DESC: Kotak report predicts muted growth for large IT firms due to AI-led deflation and weak demand, while mid-tier players are set to outperform. LABEL: TAGS: Business News, India, Technology News LABEL: SLUG: it-sector-growth-q2fy27-kotak-report
AI Deflation, Weak Demand to Keep Large IT Growth Muted in Q2FY27
India’s major IT giants are bracing for a challenging period as they head into the second quarter of fiscal year 2027. According to a recent report by Kotak Institutional Equities, the industry is facing a dual challenge of AI-driven deflation and sluggish demand, which is expected to keep growth rates for large-cap companies subdued.
While the heavyweights struggle to maintain momentum, the report highlights a diverging trend where mid-tier IT firms are poised to outperform their larger counterparts through superior execution and market-share expansion.
The AI Deflation Trap
One of the most significant shifts identified in the report is the impact of Artificial Intelligence on pricing. As enterprises increasingly turn to AI to enhance productivity and slash operational costs, the traditional revenue models of IT service providers are under scrutiny. The rise of open-source and open-weight AI models is further intensifying this pricing pressure.
Kotak’s analysis suggests that the industry is seeing a tangible shift in how technology is being utilized:
- Cost-Cutting Focus: Most enterprises are currently using AI as a tool for efficiency and cost reduction rather than a driver for new revenue streams.
- Pricing Pressure: The adoption of open-source models is expected to lead to significant pricing competition.
- Deflationary Impact: The report estimates a gross deflation of approximately 7% and a net deflation of 3.5% for companies.
This AI-led deflation is no longer a theoretical threat; it is actively becoming visible within the base business of many service providers.
Mid-Tier Firms vs. Large IT Incumbents
The report paints a picture of two different worlds within the Indian IT landscape. Large-cap, or "Tier 1," companies are currently in a defensive posture, focusing heavily on protecting their existing revenue streams amidst a seasonally strong quarter that is nonetheless expected to yield muted results.
In contrast, mid-tier companies are acting as challengers. By leveraging stronger execution and capturing market share from larger players, these mid-sized firms are expected to see stable to improving margins. While large firms deal with macroeconomic headwinds, the mid-tier segment is expected to emerge as the winner in terms of growth trajectory.
Margins and the Rupee Factor
Profitability remains a key concern for investors. For large IT firms, margins are expected to remain either stable or face a marginal year-on-year decline. This volatility is largely tied to the timing of wage revision cycles, which have been inconsistent across the sector.
However, there is a silver lining in currency fluctuations. The report notes that the depreciation of the rupee—which fell 0.8% quarter-on-quarter and 8.4% year-on-year—has acted as a buffer, helping to offset some of the pricing pressures and supporting margins. Nevertheless, the full benefit of this depreciation may not hit net profits immediately due to various cash-flow hedging strategies employed by these companies.
Broader Sector Outlook
The cautious sentiment is not limited to the IT services sector alone. The report also notes that Engineering Research and Development (ERD) companies are likely to report lackluster growth in the upcoming quarter, mirroring the broader trend of cautious enterprise spending.