A slowdown in factory activity deepened in July as order books shrank by the most in over four years, suggesting a broad stagnation in the manufacturing sector, a survey showed on Thursday.
The HSBC Manufacturing Purchasing Managers' Index (PMI), compiled by Markit, edged down to 50.1 in July from 50.3 in May.
The index, which gauges business activity in Indian factories but not its utilities, has been running close to the 50 mark that separates growth from contraction since May, but has held above it for over four years.
"Activity in the manufacturing sector was broadly flat in July. Output fell by less, but order flows weakened led by slower growth in export orders," said Leif Eskesen, a chief economist at HSBC.
The new orders sub-index, an overall indicator of firms' order books, fell to 49.5 in July from 49.7 in June, as growth in export orders, while still positive, slowed sharply in July.
The survey also showed output shrank for a third consecutive month in July, while employment rose fractionally.
The Indian economy is stuck in a quagmire of low growth, persistent inflation, a wide current account deficit and a rapidly weakening currency. Policy measures to tackle any one of these will likely worsen the other factors.
While the economy grew at its slowest pace in a decade in the last fiscal year, economic data since then has suggested further pain amidst an exports slump, while the rupee has fallen to record lows.
By virtue of being a net importing country, a weakening currency quickly inflates India's import bill leading to higher inflation and a wider current account deficit, which in turn pressures growth and the country's foreign exchange reserves.
The Reserve Bank of India, in a bid to support the rupee, tightened liquidity conditions in money markets and increased short term interest rates.
While those measures supported the rupee and helped it ease off its record low of 61.21 to the dollar, the currency headed back to those levels on Wednesday after the central bank governor said those steps were temporary and would be rolled back once the currency stabilised.
Even so, the central bank has limited tools to handle the situation. Whatever it does will do little more than buy time for Prime Minister Manmohan Singh's weak coalition government to undertake reforms needed attract foreign capital inflows, reduce the current account deficit and boost investment.
With the economy growing at a snail's pace and inflation well under the five per cent considered as the central bank's comfort zone, increasing the benchmark rate would further deepen the downturn while having limited impact on the currency.
The latest PMI however showed inflation pressures intensified in July with both the input and output costs rising at a faster pace.
"The data suggests that the RBI will likely have to keep policy rates on hold for a while given lingering inflation risks and that the recently introduced currency stabilisation measures will not be lifted anytime soon," Eskesen said.