Large caps stabilising, mid-tiers outperforming, AI deflation weighing on guidance across the globe
The Indian IT sector has had a complicated year. Growth has been modest. Guidance cuts have arrived from Accenture, Infosys, Cognizant and others. And yet the stocks have rallied — supported by reasonable valuations, attractive dividend yields and what Systematix describes as “disclosure of steady progress in AI revenues.”
The question every investor is now asking is whether the rally has legs or whether it has run ahead of the fundamentals. “IT-services stocks have recently rallied on reasonable valuations, attractive yields and disclosure of steady progress in AI revenues, leaving the sector’s risk-reward broadly balanced,” says Sytematix in a report.
Modest Growth, Resilient Margins
The Q1FY27 numbers were exactly what the word modest implies. Tier-I companies delivered revenue growth of negative 1.2% to positive 2.6% quarter-on-quarter in constant currency terms — a wide range that masks the divergence within the cohort. TCS reported 0.4% QoQ CC growth. Tech Mahindra led the large-cap pack with 2.6% QoQ CC growth — “its strongest performance in 15 quarters,” the Systematix report notes. Infosys, HCL Tech and Wipro weighed on the large-cap aggregate, which came in at just 0.4% QoQ CC including inorganic contributions.
Year-on-year the picture improved. “Aggregate YoY CC growth improved to 3.7% from 2.5% in 4QFY26 and 0.9% in 1QFY26,” Systematix notes.
Mid-tier companies continued their structural outperformance over large caps. Hexaware led with approximately 4.2% QoQ CC organic growth, followed by Persistent, Mphasis and Coforge — “led by deal ramp-ups, healthy growth in key accounts and improved execution.” This is the fourth or fifth consecutive quarter in which mid-tiers have outperformed the large-cap cohort, reinforcing the thesis that scale is currently a disadvantage in an environment where deal structures are complex and execution agility matters more than global reach.
The AI Deflation Reality
The most important structural observation in Systematix’s note is not about any single company’s quarterly performance — it is about what is happening to the economics of IT services at an industry level. “Accenture, Infosys, Cognizant, Globant, EPAM and Hexaware cut organic growth guidance, due to AI-led deflation, client or industry specific issues, pricing pressure and macro uncertainties,” the report states.
AI-led deflation means clients are getting more output per dollar of IT services spending as AI tools improve productivity. For IT services companies that bill on time-and-materials, this is directly deflationary — fewer hours needed for the same output means lower revenue per engagement. The managed-services model is similarly affected as AI reduces the labour content of infrastructure management and application support contracts.
“AI-led revenue deflation, the erosion of labour-arbitrage advantages and rising pricing pressure in managed-services deals are likely to weigh on growth in the near to medium term,” Systematix states — a prognosis that frames the sector’s challenge in its starkest terms.
Deal wins are mixed and increasingly skewed toward cost takeout, vendor consolidation and GCC setup mandates rather than large discretionary transformation programmes — categories that are by definition deflationary in their structure.
Holding for Now
The margin picture is where the sector has most impressed relative to the growth disappointment. Most Tier-I firms, with the exception of Wipro, reported resilient EBIT margins despite a long list of headwinds — wage hikes, AI investment, sales investments, restructuring costs, integration challenges and program terminations. “These headwinds were offset by tighter execution, G&A optimisation, lower pass-through revenue, improved utilisation and currency tailwinds,” the report notes.
“With limited scope for traditional margin levers, companies are likely to rely on greater internal AI adoption, G&A rationalisation, lower amortisation and operating leverage to sustain profitability.” The traditional levers — offshore shift, pyramid restructuring, utilisation improvement — have largely been exhausted. The next phase of margin defence requires AI-driven productivity in internal operations, which is real but less predictable in its magnitude and timing than the structural levers previously available. Mid-tiers faced more visible margin pressure, with deal ramp-up costs, acquisition integration and higher onsite expenses compressing margins sequentially.
Whether It Can Continue
The Nifty IT index has outperformed the broader market by approximately 3% over the past month. Systematix attributes this to three factors: reasonable valuations after a prolonged period of underperformance, attractive dividend yields that have attracted income-oriented capital, and the AI revenue disclosures that suggest the sector is participating in rather than being destroyed by the AI transition. These are all legitimate reasons to own the sector — but they are also largely already reflected in prices after the rally.
“Following the recent rally, sector risk-reward appears more balanced, with broad-based multiple expansion constrained by high Fed rates, crowded-out IT budgets and intense competition,” Systematix states — a balanced assessment that neither chases the rally nor dismisses the sector’s long-term relevance.
Among large caps, Tech Mahindra is preferred — its 2.6% QoQ CC growth, strongest in 15 quarters, reflects genuine operational improvement under a management team that has spent two years restructuring the business for sustainable growth. Among mid-caps, Coforge is preferred — “supported by market-share gains, capability building and healthy deal wins,” notes Systematix.