GenAI deflation is accelerating, West Asia is hitting revenues, guidance midpoints are out of reach — Kotak cuts fair values by up to 21% and tells investors to back challengers over incumbents
The India IT sector has spent the last eighteen months navigating a slowdown that most analysts expected to be temporary. Kotak Institutional Equities’ latest sector note suggests the adjustment is not yet complete — and the reason is not the macro alone. Artificial intelligence is beginning to deflate revenue in ways that are measurable, and the pace of that deflation is moving faster than the industry had modelled. Kotak maintains a Neutral stance on the sector, cuts fair values by up to 21% across covered companies, and makes a pointed stock selection call: back challengers over incumbents, with TCS as the only large-cap worth owning and Coforge, Hexaware and Indegene as the preferred mid-tier names.
A Seasonally Strong Quarter?
June is historically one of the stronger quarters for Indian IT — more billing days, seasonal project ramp-ups, and fiscal year-end spending by Western clients. This year, Kotak expects the seasonality to be overwhelmed by two specific headwinds.
The first is the West Asia crisis, which is creating both direct revenue impact — through clients in the region deferring or reducing technology spending — and indirect impact through supply chain and sentiment effects on global enterprise budgets. The second is AI deflation — “productivity pass-throughs in managed services contracts” flowing through in real time, compressing the revenue that large IT companies bill for work that AI tools are now doing faster with fewer human hours.
The revenue growth forecasts are sobering. HCLT’s services growth is expected at -1% sequentially. Wipro at -1.1%. TCS at flat. Infosys at just 1% organic growth quarter-on-quarter. TechM is the lone standout, expected at 1% sequential growth. For a sector where even modest sequential growth has historically been considered weak, these are numbers that challenge the narrative of imminent recovery.
The GenAI Deflation Call
This is the most important and differentiated part of Kotak’s note. The brokerage has moved its GenAI deflation assumption to the upper end of its 3-3.5% band — a revision driven by the observation that “frontier model improvements in software-related tasks have outpaced our earlier expectations.” What this means in practice is that AI models are now good enough at coding, testing, documentation and certain analytical tasks that large IT companies are being asked — and in some cases contractually required — to pass through the productivity benefits to clients in the form of lower bills.
This is not a theoretical risk. It is showing up in managed services contract renewals, where clients are explicitly negotiating lower rates on the basis of AI-assisted delivery. The revenue impact — 0-1% cuts to FY2027-29 estimates — may look modest in isolation, but combined with the cost of equity increase that Kotak has also applied to capture “higher medium-term disruption risk,” the effect on fair values is material: cuts of up to 21% across certain names.
“The rapid improvement in frontier model capabilities forces us to bake in additional GenAI deflation,” the report states — a sentence that captures the uncomfortable reality facing an industry that built its growth model on the assumption that AI would be additive rather than substitutive to billable hours.
Margins
The one positive in the near-term picture is margins — and the source of that positive is currency rather than operational improvement. The rupee has depreciated 2.6% sequentially and 9.7% year-on-year, providing a meaningful translation boost to rupee-reported revenues and margins for companies with dollar-denominated contracts. Kotak expects stable EBIT margins for most companies, with TCS as an exception given wage increases being absorbed in the current quarter.
The currency benefit, however, comes with a caveat. Cash-flow hedging means the translation of rupee depreciation into net profit is not immediate for several companies. TechM, LTM, Coforge and Hexaware are all expected to report meaningful forex losses in Q1FY27 as hedges lag the spot rate movement. The margin picture, in other words, is more complicated at the PAT level than the EBIT level.
Guidance
Annual guidance, set at the beginning of FY27, is already looking stretched. Kotak’s assessment is that most large companies will struggle to hit the midpoint of their stated ranges — a conservative signal from a brokerage that typically gives management guidance the benefit of the doubt.
Infosys is expected to revise its FY27 revenue growth guidance upward to 2-3.5% from 1.5-3.5% — but Kotak notes that this revision will include approximately 110 basis points from the Optimum acquisition, meaning organic growth remains at the low end. HCLT requires sequential growth of 0.8-2.7% in every remaining quarter of FY27 to hit its annual guidance of 1.5-4.5% — Kotak forecasts 1.8%, which puts the company at the lower end of its own range. Wipro is expected to guide for -2% to flat revenue growth for the September 2026 quarter — a backward-looking number that signals no near-term acceleration.
Challengers Over Incumbents
The stock selection framework Kotak articulates is clear and worth internalising. Challengers — mid-tier IT companies that are nimbler, more focused on specific verticals, and less exposed to the managed services contracts where AI deflation is most acute — are expected to continue outperforming incumbents.
Among challengers, Kotak’s preferred picks are Coforge, Hexaware and Indegene — three companies at different points of their growth journeys but sharing the characteristic of operating in domains where AI is more enabler than disruptor in the near term, and where management execution has been consistently strong. Among incumbents, TCS is the single preferred pick — not because the growth outlook is compelling, but because its valuation discount to peers makes it the most defensible large-cap in an environment where multiples are being compressed across the board.
The Neutral sector stance reflects a setup that Kotak describes as interesting but incomplete. “Valuations limit downside, but a re-rating needs growth to accelerate or commercial constructs to capture AI value — neither of which is visible yet,” the report states. It is an honest framing of a sector that is neither cheap enough to buy indiscriminately nor expensive enough to sell aggressively.
For Indian IT Investors
| Company | Expected Q1FY27 Growth | Kotak Preference |
|---|---|---|
| TCS | Flat QoQ | BUY — preferred incumbent |
| Infosys | ~1% organic QoQ | Not preferred |
| HCLT | -1% services QoQ | Not preferred |
| Wipro | -1.1% QoQ | Not preferred |
| TechM | ~1% QoQ | Not preferred |
| Coforge | Outperformer | Preferred challenger |
| Hexaware | Outperformer | Preferred challenger |
| Indegene | Outperformer | Preferred challenger |
Fair value cuts across the sector range from 2% to 21% — with the larger cuts applied to companies with higher AI deflation exposure and lower valuation buffers.