India's industrial output in May rose at a much slower than expected pace, indicating taut monetary policy and high inflation were acting as brakes on the economy, although the RBI is still expected to raise rates later this month to contain stubbornly high inflation.

The annual 5.6 per cent growth in production at factories, mines and utilities was its slowest in nine months under a new data series, well below the forecast for an 8.2 per cent rise in a Reuters' poll, in the latest sign of slowing growth in Asia's third-largest economy.

"Despite this lower-than-expected release, which in turn confirms the moderating growth story, we still expect the RBI (Reserve Bank of India) to hike rates by 25 bps in its July 26 meeting as inflationary pressures are still strong," said Anubhuti Sahay, economist at Standard Chartered Bank in Mumbai.

The industrial output figure for April was revised down to 5.8 per cent from 6.3 per cent while manufacturing, which contributes about 80 per cent to overall industrial output, grew an annual 5.6 per cent in May compared with a revised 6.3 per cent a month earlier.

With headline inflation hovering around 9 per cent, the RBI is widely expected to raise rates later this month, which would be the 11th increase since March 2010.

A recent rise in state-set diesel prices is expected to add upward pressure on inflation.

Stocks extended losses after the data release and were down 1.3 per cent, although bond yields and swap rates, already down on the day on global risk aversion, were little changed.

India's infrastructure sector, which includes cement, steel and refining, grew 5.3 per cent in May, slightly faster than the annual growth of 5.2 per cent clocked in April. The sector contributes about 26 per cent to the index of industrial output.

Growth in India's manufacturing sector, which eased slightly in May, lost steam last month, with the factory PMI for June sliding to a nine-month low.

Private economists have been revising down their forecasts for growth in the current fiscal year, with many expecting India to grow less than 8 percent, after it expanded 8.5 percent in the year that ended in March.

Bank credit on the year as of June 17 was up almost 21 per cent, with bank deposits lagging behind at over 18 per cent.

Growth in money supply was slower at just over 17 per cent, indicating banks are increasingly facing problems in lending at high interest rates, which in turn has led to a dampening of investment demand in the economy.

However, there are early signs of an uptick in investment demand. CLSA said in a recent report that the growth moderation in the economy would be temporary and that the old IIP series was overstating the extent of moderation.

Foreign direct investment into India during April-May rose an annual 77 per cent to $7.8 billion, a sign of improved momentum after the full-year inbound FDI fell 25 per cent in the fiscal year through March as investors were deterred by a spate of corruption scandals and delays in project implementation.

Bleak Global Outlook

Japanese consumer confidence improved for a second straight month in June, indicating that the world's third largest economy will resume a moderate recovery in autumn.

However, a drop in China's crude imports and disappointing U.S. employment data reinforced fears of a demand slowdown in the world's top two energy consumers.

Fresh concerns that Italy, the euro zone's third-largest economy, could be forced into a financial crisis like Greece, Ireland and Portugal has added to a bleak global scenario.

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