After a string of sub-par results, the results of the four largest Indian IT services companies for third quarter of FY25 indicate an improvement in prospects. Both TCS’ and Infosys’ managements have highlighted a pickup in discretionary spending by clients, especially in the BFSI vertical which accounts for about 30 per cent of their revenues. TCS, Infosys and HCL Tech are now expected to close FY25 with constant currency revenue growth in the range of 4.5-5 per cent.

However, the industry may not be out of the woods yet. For one, management commentary indicates only a cautious sense of optimism. Big players are steeling for a second consecutive year of single digit constant-currency revenue growth, whereas double-digit growth was taken for granted during the digitisation boom in 2021-22 and is still factored into stock market valuations of IT stocks. While some companies have said they aspire for double-digit growth, CEO aspirational targets are not always met; the aspirational margin band set by TCS many years ago, for instance, remains elusive. Two, Trump’s return to US presidency creates uncertainties about what his tariff plans and revamped migration policies will do to the US economy, IT budgets and the trend of offshoring. Three, data trends suggest that IT majors could be decoupling from the North American market (it accounts for 50 to 64 per cent of revenues for the top four companies) at a time when the US economy has defied all sceptics to report robust economic growth.

US economic data has surprised on the upside for the last two years — and yet, this is not reflected in equal measure in the revenue growth of IT services giants. This raises the question of whether there are structural changes afoot in the demand for such services. Adding to the volatile mix is the generative AI revolution and its disruptive effects. In the near term, clients need to organise their troves of data to make them AI-ready and this offers an opportunity for IT services. But it is as yet unclear how AI adoption will play out beyond this, if AI does make inroads into coding functions. While Indian IT services companies have a track record of successfully adapting to earlier disruptions from digitisation and transition to the cloud, AI disruption could be their biggest challenge yet.

This places IT services companies at a critical inflection point. To be ahead of the curve on AI, they need to invest aggressively in human assets and intellectual property. Yet, in the last two years, these companies have focused relentlessly on profit margins while returning capital to shareholders, with payout ratios at 75-90 per cent of profits. This reflects a short-term mindset. Long-term growth amid AI disruption may require companies to compromise on margins and free cash flows, to ratchet up investments in intellectual property and skilling. Should IT majors miss the bus, they may be consigned to single-digit growth for a long time.