Why has AI business growth not yet brought an inflection point for the industry?

  • Morgan Stanley believes India’s IT services industry is in a transition phase of AI deployment: new projects are beginning to move from trials into production, but AI currently accounts for only about 10% of industry revenue, too little to offset pricing pressure on existing businesses.
  • Large language models have shortened software development cycles, while clients are also consolidating vendors, intensifying competition for renewals. Service providers must also increase spending on sales, delivery and partners, and pass some productivity gains to clients upfront, putting near-term margins under pressure.
  • The bank expects approximately 50% to 60% of existing business to go through a contract renewal over the next 12 to 18 months. Until then, companies will need higher order bookings to maintain similar revenue growth rates.

How large must AI’s share become before growth can turn?

  • In the previous cloud and digital cycle, industry growth reached an inflection point when digital business accounted for 20% to 25% of revenue. At the time, digital business grew at a compound annual rate of more than 30% for several consecutive years, while non-digital business stagnated or declined slightly.
  • Using this as a reference, Morgan Stanley expects AI’s share of revenue to reach 20% to 25% in the second half of 2028 under its base case, with industry revenue growth potentially reaching an inflection point at the end of 2028 or early 2029. Under its bullish case, that share could be reached in the first half of 2028.
  • Taking TCS as an example, the bank’s base case assumes compound annual AI revenue growth of 51% from December 2025 to December 2028, a compound annual decline of 2.1% in non-AI revenue, and compound annual growth of 2.9% in total revenue. Under the bear case, the respective rates are growth of 34.8% and a decline of 4.3%, with total revenue falling at a compound annual rate of 1%. None of these scenarios includes the consolidation of MHP or potential new acquisitions.

When might valuations rise again after bottoming out?

  • TCS’s two-year forward price-to-earnings ratio fell to 12.5 times in the current cycle, below the low of around 13 times in the previous cloud cycle, before rebounding. Morgan Stanley believes the valuation trough for this cycle may already have occurred.
  • The bank’s base case assumes a modest acceleration in organic revenue growth in fiscal 2028. If this expectation is substantially revised down, valuations could return to their previous lows.
  • In previous cycles, stocks typically began to rerate three quarters before the inflection point in revenue growth and peaked after two quarters of strong growth. Based on that experience, Morgan Stanley expects the current rerating could occur between the end of 2027 and early 2028; before then, share prices may move largely sideways.

Which companies could benefit first?

  • Around the previous growth inflection point, companies that moved more quickly to transform their digital businesses were the first to outperform; a low starting price-to-earnings ratio did not necessarily confer an advantage. Only after company growth rates converged following the pandemic did the previous laggards significantly outperform.
  • Morgan Stanley expects companies’ revenue growth rates to remain divergent in fiscal 2028, and valuation differences to persist as a result. Among the major companies, its order of preference is HCL Technologies, Tech Mahindra, TCS, Infosys and Wipro.