Focus may shift to CY26 budgets and AI scaling as IT growth remains muted in Q3

Indian IT services firms are expected to deliver muted growth in Q3 FY26, as seasonal furloughs and fewer working days offset a still-cautious demand environment. The quarter is shaping up as a holding phase, with market focus shifting to CY26 client budget visibility, the pace of AI-led deal scaling, and signs of recovery in discretionary spending.

The near-term outlook for IT services remains muted, with Q3 expected to be seasonally soft, which is reflective of current demand conditions. Similar to Q3FY25, furloughs and fewer working days are expected to constrain sequential revenue growth.

According to a PL Capital report, margin performance is expected to be flat to marginally positive, aided partly by INR depreciation, though wage hikes and furloughs will limit upside. Structurally, H2 tends to be weaker for IT services, and the underlying demand environment remains largely unchanged, with growth still driven by a handful of verticals rather than a broad-based recovery.

Deal activity remains steady but skewed toward renewals, supported by year-end budget flushes, while new deal signings are expected to remain weak. Clients remain cautious amid macro and tariff-related uncertainties, delaying incremental commitments to large programmes. As a result, demand is expected to stay steady, at best marginally incremental, until early CY26, when enterprise planning cycles reset, and tech budgets are finalised, potentially improving sentiment and spending visibility.

For 3Q, aggregate revenue for top IT firms is expected to grow in high single digits YoY, with EBIT and PAT growth broadly tracking revenue in INR terms. Growth among large caps is likely to be muted, with exceptions aided by software seasonality or large deal ramp-ups.

An Emkay report observed that cross-currency is expected to have a marginal impact on reported USD revenue growth in Q3. Tier-1 players are expected to post CC revenue growth of 0-3 per cent, while reported USD revenue growth would be pulled back by 10-40bps, given cross-currency headwinds. Tier-2 companies may see CC revenue growth range of -0.4 per cent to 5.5 per cent, with headwinds of 10-40bps on reported USD revenue.

Choice Institutional Equities said the risk-reward profile has turned favourable for the sector, with large-caps trading near their 5-year average multiples and mid-tier valuations well below prior peaks. It also saw Accenture’s Q1 results as a strong indicator of improving demand, signalling an AI-led IT demand recovery. Recent US Fed rate cuts are also expected to support improved client budget releases going forward.

“During the quarter, INR depreciated by 2.2 per cent q-o-q against USD to an average rate of 89.2, which will bode well for top-line and margins in INR terms. However, cross-currency movements — measured as a basket of major currencies against the USD — are expected to slightly impact growth in USD terms for the quarter by around 0-0.5 per cent,” it said.

AI

According to Emkay, Indian IT services firms have moved decisively, from experimenting with AI and GenAI to embedding it across the full lifecycle of client engagements. However, the revenue derived through the AI stream is negligible.

“AI is no longer positioned as a standalone offering but is increasingly woven into application development, modernisation, testing, infra ops, data platforms, and business process delivery. Despite this operational centrality, AI’s direct revenue contribution remains limited and opaque, reflecting both conservative disclosure practices and the fact that most AI work is bundled within larger transformation deals rather than sold independently. Expansion in client tech budgets is not driving current AI adoption. Spending continues to be largely reallocated from existing IT and digital transformation pools, indicating that AI is, for now, a substitution layer within tech spend rather than a net new demand driver. Till AI transitions from being funded through reshuffled digital budgets to attracting incremental ring-fenced spend, revenue contribution is likely to lag operational importance,” the report said.

PL Capital noted that large hi-tech and SaaS companies are enjoying the benefits of early investments in AI. However, IT services vendors are required to deliver tailored, enterprise-specific offerings rather than plug-and-play solutions, which delays the realisation of immediate AI benefits.

A Motilal Oswal Financial Services (MOFSL) report added that AI services demand could begin to improve from mid-2026 as hardware-led AI capex intensity moderates and spending gradually shifts toward software, platforms, and services. The Mar-Apr’26 budget reset period may serve as an initial indicator, with some AI programmes potentially transitioning from preparation to early deployment.

Early signs of AI strategy formation are visible, with IT companies building AI-led capabilities through targeted acquisitions and partnerships — such as TCS, Wipro, Coforge, and HEXT — positioning for early AI services demand. At the ecosystem level, leading LLM players are formalising channel partnerships with system integrators, signalling the emergence of a structured AI services layer. Momentum is expected to build over the next six months, with AI services demand likely to inflect into CY26.

Mid Tier vs Large Tier

MOFSL observed that q-o-q CC growth for large-cap IT firms is expected in the range of 0.3–2.3 per cent, while mid-caps are likely to outperform with a wider range of –2.5 per cent to 3.5 per cent. Among large caps, TCS and Infosys are expected to post modest growth of around 0.5 per cent and 0.3 per cent q-o-q CC, respectively. HCLTech should lead with around 2.3 per cent growth on software seasonality, followed by LTIMindtree at about 2.2 per cent on large-deal ramp-ups. Wipro is expected to grow by around 1.5 per cent q-o-q CC, aided by Harman, while Tech Mahindra may see roughly 0.5 per cent growth.

Mid-tier performance is expected to be led by Persistent at 3.5 per cent q-o-q CC, with Coforge at 3 per cent and Mphasis at 1.3 per cent also delivering healthy growth. Coforge is emerging as a structurally strong mid-cap, supported by a solid order book, resilient client spending, and the Encora acquisition, which strengthens its presence in Hi-Tech and Healthcare.

Verticals

Sector-wise, BFSI remains relatively resilient and continues to show positive momentum, supported by rate cuts, despite some furloughs. Hi-Tech growth is broadly flat as large deals remain in transition, while travel and transportation is benefiting from ongoing deal ramp-ups. Manufacturing trends are mixed — auto remains under pressure, weighing on both manufacturing and ER&D players, while core industrials are steady. Communication also remains soft. Other verticals, including retail and healthcare, show mixed growth trends.

(with inputs from Vallari Sanzgiri)

Published on January 4, 2026