India’s showpiece software industry is facing a moment of reckoning.

The country’s biggest private sector employer Tata Consultancy Services (TCS) – also its largest IT services company – has announced it will cut more than 12,000 jobs at middle and senior management levels. This will reduce the firm’s workforce by 2%.

The Mumbai-headquartered software behemoth employs over half-a-million IT workers and is considered a bellwether for business sentiment across India’s $283bn software industry. It forms the backbone of formal, white-collar employment in the country.

The decision, TCS says, was taken to make the company “future ready” as it invests in new areas and deploys artificial intelligence at scale amid seismic disruptions in its traditional business model.

Companies like TCS have, for decades, relied on cheap skilled labour to produce software for global clients at lower costs, but this has been upended by AI automating tasks and clients demanding more innovative solutions, rather than just cost savings on manpower.

“A number of re-skilling and redeployment initiatives have been under way,” TCS said in a statement, adding it will be “releasing associates from the organisation whose deployment may not be feasible”.

“Across IT companies, people managers are being let go while the doers are being kept to rationalise the workforce and bring in efficiencies,” Neeti Sharma, CEO of staffing firm TeamLease Digital told the BBC.

She added that “there’s been a massive spike” in emerging tech hiring in areas such as AI, cloud, data security, but it is not at the same intensity at which people are being fired.

TCS’s announcement also highlights the sharp “skills mismatch” in the country’s software industry, experts say.

As generative AI leads to a rapid enhancement of productivity, “this technology shift is forcing businesses to reassess their workforce structure and analyse if resources should be redirected toward roles that complement AI capabilities,” Rishi Shah, economist with Grant Thornton Bharat told the BBC.

According to the industry body Nasscom, India needs a million AI professionals by 2026, but not even 20% of the country’s IT professionals are AI-skilled.

While up-skilling spends by tech companies have significantly spiked as they rush to prepare a new pool of AI talent for the future, those without the requisite skills are being shown the door.

Besides the structural shifts brought about by the advent of AI, TCS’s announcement also “reflects the broader growth challenges being faced by India’s IT sector”, according to global investment banking firm Jeffries.

“Aggregate net hiring at industry level has been weak since FY22 [financial year 2022], mainly due to the prolonged moderation in demand outlook,” Jeffries said in a note.

Demand for IT services in the US – which contributes to half of the revenue for Indian software majors – has been impacted by Donald Trump’s tariffs.

While tariffs chiefly target physical goods, analysts say companies are pausing on discretionary IT spending as they reconsider the economic impact of tariff uncertainties and their global sourcing strategies.

Rising AI adoption is also driving US companies to negotiate lower costs, forcing people heavy IT firms to work with fewer employees, according to Jeffries.

The ripple effects of this have begun to be felt in cities like Bengaluru, Hyderabad and Pune – once epicentres of India’s IT boom. Some 50,000 people in the industry lost their jobs last year, according to one estimate. And there was a 72% drop in net employee additions at India’s top six IT services companies.

All of this could have cascading effects on India’s broader economy, which has struggled to create jobs for the millions of young graduates that enter the workforce every year.

In the absence of a strong manufacturing sector, these software companies – which made India the world’s back office in the 1990s – were the preferred employment option for hundreds of thousands of new IT workers. They birthed a new, affluent middle class, spawning growth in many cities and fueling demand for cars and homes.

But as stable, well-paying jobs shrink, there are now questions over India’s services-led economic boom.

Until just a few years ago, India’s IT majors would absorb 600,000 fresh graduates every year. In the last two years, that number has dramatically fallen to about 150,000, according to TeamLease Digital.

Other emerging sectors such as financial technology startups and GCCs (global capability centres) – which are off-shore units of multinational companies that perform supporting tasks like IT, finance or research and development – are absorbing the rest, but at least “20-25% of fresh graduates will have no jobs,” says Ms Sharma.

She adds that the “GCCs will never match the volume of hiring that the IT companies did”.

Several top business leaders in India have begun flagging the economic consequences of these trends.

India’s trimmed down IT sector could “negatively impact many allied services and industries, crash real estate and give a big blow to premium consumption,” D Muthukrishnan, one of south India’s largest distributor of mutual-funds wrote on X, reacting to TCS’s announcement.

A few months ago Arindam Paul, entrepreneur and founder of the motor technology company Atomberg, warned of the potentially crippling impact of AI on India’s middle class in a LinkedIn post.

“Almost 40-50% white collar jobs that exist today might cease to exist,” Paul wrote. “And that would mean the end of the middle class and the consumption story.”

How quickly Indian tech giants adapt to the gamut of disruptions being brought by the AI revolution will decide whether the country can retain its edge as a global technology player. And whether it can expand its consuming middle-class that can keep its GDP growth on track.

Follow BBC News India on Instagram, YouTube, X and Facebook.