Growth in India's industrial output in July slumped to its lowest in nearly two years as high interest rates cooled Asia's third largest economy and put pressure on the Reserve Bank of India (RBI) to pause its monetary tightening despite stubbornly high inflation.

Despite the weak data, the RBI is still expected to raise rates at its Friday policy review.

"We expect the RBI to persevere with a 25 bps hike on Friday though the trajectory thereafter will hinge on the inflation trend in the coming months," said Rashika Rao, an economist with Forecast Pte in Singapore.

Industrial output rose just 3.3 per cent in July, dragged down by a huge fall in capital goods production.

The data was well below a median forecast of 6.2 per cent in a Reuters poll, government data showed on Monday.

The BSE Sensex extended losses to more than 2 per cent and the rupee weakened to its lowest in more than a year on Monday after the data was published.

The slowdown was driven by a drop in capital goods production from 38.2 per cent growth last month to a 15.2 per cent contraction this month and a smaller drop in manufacturing.

Some cautioned that such high volatility raised doubts about the reliability of the data.

"We think that this data cannot be a credible guide to RBI policy. Inflation will continue to hold the key for the September rate decision," said A. Prasanna, an economist with ICICI Securities Primary Dealership in Mumbai.

Manufacturing output, which constitutes about 76 per cent of the industrial production index, rose an annual 2.3 per cent, the federal statistics office said in a statement.

With headline inflation at 9.22 per cent in July the RBI is expected to raise rates on Friday for the 12th time since March 2010. August inflation data will be released on Wednesday.

Euro zone debt woes and a weak outlook for the US economy have added to home-grown headaches for Indian policymakers.

Weakness in the west is taking a global toll on manufacturing. South Korea's manufacturing sector shrank in August for the first time in 10 months as new export orders decreased, while China's manufacturing contracted slightly for the second consecutive month.

What Experts Think


Dariusz Kowalczyk, Senior Economist & Strategist At Credit Agricole CIB In Hong Kong:

"Dramatic drop in Indian industrial output, led by manufacturing. Only partly due to base effects. The data confirms slowdown of growth and may cause the RBI to stay pat on rates on Friday.

"It is negative for the INR and may well push INR OIS rates down. Rate tightening cycle in Asia would then be over."

Radhika Rao, Economist, Forecast PTE, Singapore:

"July factory output disappointed, dragged lower by sluggish manufacturing production and weak capital goods output. Prima facie, the revised series has not been able to filter out the volatility in the capital goods component.

"We expect the RBI to persevere with a 25 bps hike on Friday though trajectory thereafter will hinge on inflation trend in the coming months. Slowdown in car sales and softness in other production-indicators is along RBI's expectations and thereby is unlikely to prompt them to pause this week."

Rupa Rege Nitsure, Chief Economist, Bank Of Baroda, Mumbai:

"High volatility in capital goods services has been masking the true movements of IIP numbers. It makes more sense to look at the cumulative figures than the month on month variations.

"However, today's figures definitely indicate a slowdown in overall manufacturing growth momentum. This means India's GDP growth for the full year may slip below 7.5 per cent. The industrial production in the busy season will be something that one has to closely look out for.

"For RBI's monetary policy stance, inflation for August due on Sept. 14 will carry more weight than today's IIP numbers. I think inflation will be close to double digits and since this is going to be last of the hikes in the current cycle, the RBI may prefer to deliver a strong 50 bps increase and then pause."

Anubhuti Sahay, Economist, Standard Chartered Bank, Mumbai:

"The ugly IIP print at 3.3 per cent is the weakest since October 2009 and is a shocker especially after an 8.8 per cent y/y print in the previous month.

"This once again reminds us of the increased volatility in the series and thus its reduced role in monetary policy decision.

"This time it is likely to add up to the market view that the RBI might pause on Sept. 16, but we still expect a 25 bps increase in the repo rate on Friday. Increased global risks can be a game changer."

Kumar Rachapudi, Fixed Income Strategist, Barclays Capital, Singapore:

"IIP is much worse than expected. Intermediate goods contributed negatively after positive contributions for the last five months. I expect the OIS (overnight indexed swap) curve to move lower and flatten further and continue to be long bonds.

"However, inflation data is key along with global financial market developments. Inflation is the stated priority of the RBI. Our base view is for a 25 bps rate hike by the RBI this week. But probability of a pause has increased due to global uncertainty."

A. Prasanna, Economist, ICICI Securities Primary Dealership, Mumbai:

"The data has lost all its relevance. It looks like capital goods have reversed completely due to volatility in a few items.

We think that this data cannot be a credible guide to RBI policy. Inflation will continue to hold the key for the September rate decision."

Shakti Satapathy, Fixed Income Analyst, A.K. Capital, Mumbai:

"The data indicates growth moderation in the economy as broadly one can make out from growth in intermediate goods.

"However, the growth in consumer goods shows the demand pressure in the economy is still prevalent, especially in the consumer non-durable segment. Hence, the RBI might resort to one more rate hike of 25 basis points in the Sept. 16 policy meet and then a pause in the rate hike cycle is more likely."


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