Blasé Capital SOFTWARE HARDSHIP

India’s information technology sector, long regarded as a steady compounder for firms and investors, grapples with one of the toughest phases in the recent decades. Growth has slowed down sharply over the past two years, stock valuations have compressed, and new structural forces from global capability centres (GCCs) to generative AI are reshaping the sector’s economics. According to data collated by Value Research, the BSE IT Index gave double-digit negative returns of minus 14 per cent over the past year, a positive 10 per cent in the past three years, and positive single-digit of nine per cent in the past five years. According to a recent CRISIL report, sector revenues are expected to grow 6-8 per cent in 2025-26, of which 4-6 per cent will be driven by the depreciation of the rupee against the major foreign currencies. The sector will register modest mid-single digit growth next year, supported by gradual recovery in core IT spending even as demand conditions remain cautious. Another report by Emkay Global Financial Services describes the ongoing phase more bluntly: “The disruptor will get disrupted.”

Emkay Global, in its analysis of the top three IT firms, TCS, Infosys, and HCL Tech, states that during the pre-pandemic phase (FY17-20), constant currency revenue growth averaged about 10 per cent annually. While the post-pandemic rebound initially lifted the rupee revenues, the underlying growth momentum weakened. Over FY24 and FY25, constant currency dollar growth averaged a mere 3.2 per cent, and 4.4 per cent year-on-year, respectively, or roughly half of the pre-pandemic levels. Operating profit growth moderated to mid-single digits. According to the brokerage house, the apparent post-Covid strength too was largely driven by a weaker rupee rather than any improvements in global structural demand. Thus, “Such low revenue growth rates need to be questioned and understood.” The report argues that the current and ongoing slowdown cannot be explained by either currency or temporary factors alone. While global macro uncertainty and geopolitical risks are often cited as the main reasons, the fact remains that global GDP growth during the recent past held up reasonably well, particularly in the US.

Yet, it was the US geography that saw the sharpest deceleration for the Indian IT sector, with firms’ American revenues growing 1-2 per cent in FY24 and FY25, compared with much healthier growths in Europe. This divergence points to structural shifts rather than cyclical weakness, and challenges the long-held belief that global IT spending will automatically revive with macro recoveries. One of the shifts is the rapid rise of GCCs. Media estimates suggest that nearly two-thirds of the global firms moved at least a tenth of their workforces from the vendors to in-house GCCs. With GCC revenues estimated to have grown nearly 40 per cent in the calendar year of 2024, it is “hard to imagine” that this expansion did not directly cannibalise IT services growth. High-value work such as digital strategy, R&D, and AI is increasingly being insourced, and this is intensifying the competition for the traditional vendors like the Indian IT firms.

Generative AI presents another inflection point. As AI-driven coding becomes more efficient and commoditised, Emkay Global believes that the pricing power for IT services may erode. “The marginal cost of writing incremental software codes will fall significantly,” which will raise the risks of revenue stagnation even if volumes rise. From a market perspective, a report by DSP Mutual Fund notes that the Indian IT stocks are now under-owned, and underperforming. The sector’s weight in the Nifty 50 is close to decadal lows, and Nifty IT index has underperformed the Nasdaq by nearly 50 per cent on a rolling three-year basis. The report argues that while this does not guarantee absolute returns, Indian IT services can offer relative outperformance if the valuations correct further and stabilise, especially given the strong balance sheets and return ratios. Leading Indian firms have begun to embed generative AI as a core strategy, rather than as a quick-fix solution. Over the next few years, some of them will emerge as AI-driven ones. However, like in the earlier phase of software services, one will need to examine if Indians occupy the bottom-rung, or climb up to the more profitable middle levels.

The consensus emerging from the various analysts is however cautious. Near-term growth is likely to remain subdued as pricing pressure, AI-led efficiency gains, and GCC competition persist. However, for long-term investors, the sector’s deep de-rating, high ROICs, and strategic role in AI enablement may provide selective opportunities. Indian IT’s next upswing cycle, analysts suggest, will depend less on headcount-led growth, and more on how effectively companies adapt to a world where technology is rewriting the rules of the industry. But tech adoption comes with costs, and other challenges. It requires huge initial investments, and Indian firms may wish to opt for inorganic growth rather than reinvent the wheel. Employees need to be re-skilled, even as layoffs become the norm. The former requires more and regular investments. The latter leads to criticism, and sobriety among the investors, who are used to lower attrition rates, and higher headcounts. The immediate gains, as some studies indicate, are not obvious. There are inherent and deliberate derailments at the middle levels even if the senior management is focused on tech adoption. The process is uneven.