Marcellus warns AI deflation threatens Indian IT workers more than firms
Investment firm Marcellus cautions that artificial intelligence will disrupt the labor arbitrage model of Indian IT services, while urging investors to navigate a stock-picker’s market amid stretched valuations.
Pramod Gubbi of investment firm Marcellus warns that artificial intelligence poses a greater risk to workers in the Indian IT sector than to the companies themselves. He cited the deflationary pressure AI places on the industry’s traditional labor arbitrage model.
The firm previously reduced cash in its small-cap strategy from approximately 40 percent to 13 percent during February and March, but has now halted fresh capital deployment. Gubbi noted that valuations are no longer as compelling following the sharp market rebound from those early-year lows.
While the corporate earnings cycle appears to have bottomed out, geopolitical tensions in West Asia and volatile oil prices threaten a sustained recovery. Consequently, the firm is currently focusing on portfolio rebalancing rather than seeking new investments in a market where attractive opportunities are few.
The historical earnings superiority of consistent compounders has narrowed significantly since the pandemic. Massive government capital expenditure and broad post-lockdown demand recovery have lifted the broader market, compressing the valuation premiums once enjoyed by traditional quality names.
Specific sectors now face structural rather than temporary challenges. Fast-moving consumer goods companies are losing market share to retailer private labels and direct-to-consumer brands fueled by digital marketing and quick commerce. Similarly, IT firms are ceding ground to global capability centers.
Gubbi emphasized that while enterprise IT infrastructure remains complex and incumbent providers retain crucial workflow knowledge, the short-term effect of AI adoption is deflationary. Savings from reduced labor intensity may eventually fund new work streams, but it remains unclear if this will offset the immediate deflationary effects on existing contracts.
Investors now face a stock picker’s environment where large caps offer no distinct advantage over mid- and small-cap equities. Gubbi argued that once structural IT challenges and the capital intensity of private sector banks are factored in, the risk-reward profile across market capitalizations is largely uniform.
Healthcare remains a core exposure across Marcellus funds, driven by health insurance expansion and supply constraints in hospitals, diagnostics, and pharmaceuticals. However, current valuations are not compelling enough to justify increasing those allocations.
Conversely, a depreciating rupee and new free trade agreements are actively boosting the competitiveness of Indian manufacturing exports. This resurgent manufacturing base is also expected to sustain non-farm rural employment, helping to offset potential economic drag from a weak monsoon or El Nino.
