IT Industry Faces Economic Headwinds

The IT sector is currently navigating through a period of sluggish growth, with industry analysts forecasting a slower pace of recovery. The sector is expected to experience moderate growth over a longer period, facing potential challenges from the macro-economic environment and ongoing technology transitions. This scenario poses increased risks to revenue growth, leading to a subdued outlook for Indian IT firms.

Analysts have noted a polarization in growth rates among various players, largely influenced by company-specific developments. "The changing tech cycle is likely to usher in a transition phase for tech services companies, similar to the 2016/17 period, causing growth to moderate in the short term," stated analysts at Morgan Stanley in a recent report. They have adjusted their dollar revenue growth forecasts downwards by 100-200 basis points, expecting growth rates of 4.5% in FY26 and 6% in FY27 for large-cap IT companies.

Market Adjustments and Future Opportunities

Jeffries has revised its stance on the IT sector to underweight, citing rising growth concerns in the US. The weakened US growth outlook is reflected in the decline of the US 10-year bond yield and increased expectations for a Fed rate cut. Additionally, the US Dollar Index's 4.2% drop over the past month may alleviate pressure on the Rupee, which has been a margin tailwind for IT companies.

Morgan Stanley highlighted that despite a 6%-18% correction in IT stocks compared to the Sensex, relative valuations remain at a five-year average. The firm sees risks to consensus revenue estimates and a potential de-rating risk for multiples back to the long-term average. However, tech shifts are expected to open up new opportunities, despite an initial slowdown in growth during the transition period. The report pointed to new addressable market opportunities, such as the modernization of legacy technology stacks using Gen AI technology, data and analytics work, and the automation of basic-level jobs, which could create efficiency benefits.