The Indian IT sector appears to have weathered the worst of its challenges, with recovery expected by 2026 as artificial intelligence services gain wider traction, according to Abhishek Pathak, IT & Tech Analyst at Motilal Oswal Financial Services.

Recovery Timeline and Catalysts

While the upcoming third quarter is expected to be a non-event due to seasonal weakness and furloughs, Pathak maintains a positive outlook for the sector over a two to three-year horizon. The catalyst for turnaround will be the resurgence of short-cycle deals, particularly in AI implementation.

"We think a leading indicator of IT recovery will be short-cycle deals sort of coming back, and these short-cycle deals will largely be AI implementation deals where enterprises will move from pilots to serious implementation," Pathak stated. He anticipates this shift to begin from mid-2026, highlighting the importance of monitoring partnership agreements between Indian IT firms and major AI developers like Anthropic and OpenAI.

Market Dynamics and Investment Strategy

On the debate between mid-caps and large-caps, Pathak noted that while mid-caps have historically held the upper hand over the last five years, large-cap stocks now offer selective value opportunities. Companies with strong infrastructure management services and data practices might initially outperform those heavily reliant on application development, which could face challenges from AI-driven productivity gains.

Stock Recommendations and Upgrades

Motilal Oswal's top picks reflect a balanced approach across market capitalizations:

Valuation and Growth Outlook

Addressing concerns about HCL Technologies' valuation premium, Pathak argued that in the current unique business cycle without a clear bellwether, any company that consistently outperforms its peers has a right to be valued at a premium. "If they maintain their growth momentum, I think the valuation premium can be justified," he noted, though acknowledging margin concerns.

Regarding Coforge's recent acquisition worth $2.50 billion, Pathak viewed it positively from a capability standpoint, despite the price being slightly expensive. "The asset is good. The only concern from our end is the potential dilution that may happen going forward in the next one year," he cautioned.

Motilal Oswal has released its preview for the upcoming third quarter IT results season, highlighting four key stock picks while projecting seasonal headwinds to impact sector growth. The brokerage expects seasonal furloughs to weigh on Q3 performance after some respite witnessed in Q2 on beaten-down expectations.

Growth Projections and Market Outlook

The brokerage has provided specific growth forecasts for the upcoming quarter, with distinct expectations for large cap and midcap segments.

Motilal Oswal believes markets will look beyond Q3 seasonality and focus on signals around the demand environment from client budgeting for calendar year 2026. The firm notes that amid macro-tariff uncertainty and a new tech cycle, clients remain cautious on committing incremental spending to large programmes.

Long-term Growth Cycle Expectations

The brokerage expects demand to remain steady, at best marginally incremental, until January 2026 as planning cycles reset and budgets firm up. Calendar year 2026 should represent the bottoming of the growth cycle, setting the stage for more meaningful acceleration in the second half of FY27 and FY28 as AI services move into scaled deployment.

Early signs of AI strategy formation are emerging with IT companies investing in AI-led capabilities via acquisitions and partnerships. Motilal Oswal expects momentum to build over the next six months, with AI services demand inflecting into calendar year 2026.

Top Stock Picks and Company-Specific Forecasts

Motilal Oswal has identified four preferred stocks across large cap and midcap segments, with detailed Q3 expectations for each company.

Large Cap Preferences

Infosys: Revenue growth may remain flat in constant currency terms due to seasonal furloughs, with H2 expected to be weaker than H1. US BFSI segment may remain resilient, while operating margins are projected to stay flat. Management is likely to maintain its guidance.

Tech Mahindra: Sequential revenue growth of 0.5% in constant currency terms is expected as furloughs partially impact growth. Margins may improve by 60 basis points with Europe picking up traction again.

Midcap Selections

Coforge: The company is expected to deliver 3% sequential growth in constant currency revenue despite furlough impacts. EBIT margin may decline by 70 basis points due to wage hikes, partially offset by lower ESOPs and other expenses.

Hexaware Tech: Constant currency revenue may decline 2.5% sequentially due to lower license revenue, regular furloughs, fewer working days, and government shutdown in the US. The CyberSolve acquisition will have a two-month impact in Q3.

Additional Company Outlook

Motilal Oswal has also provided forecasts for other major IT players:

Analyst Sentiment Overview

The brokerage's top picks have received varied analyst coverage across the investment community:

The Q3 results season will provide crucial insights into client spending patterns and demand environment signals that could shape the sector's trajectory through calendar year 2026 and beyond.