The HSBC Markit Purchasing Managers’ Index (PMI) for Indian manufacturing for September shows that industrial recovery continues to gather steam. In August, the index had fallen to 53.2 from 55.4 in July and the concern then was whether the industrial momentum was flagging.

Data for August show that exports during the month were 19.4% lower than a year ago, much better than the 28.4% year-on-year (y-o-y) decline in July. On a month-on-month (m-o-m) basis, exports have been increasing. With a recovery in the West, the outlook for exports is much brighter.

Data on non-oil imports at first glance is not so encouraging. Non-oil imports in August were lower by 25.5% y-o-y, compared with a drop of 24.5% in July and a fall of 16.5% in June. Nevertheless, that could be due to a base effect. If m-o-m numbers are considered, non-oil imports in August show a substantial jump over May.

What’s worrying, however, are the inflation numbers. The PMI data show the output prices sub-index at a one-year high, which means the increase in input prices is being passed on to consumers.

With the wholesale price index edging up, the revival in demand and manufacturers’ ability to pass on costs will add to inflationary pressures and fan inflationary expectations. That should make the Reserve Bank of India nervous. The writing is clearly on the wall for the central bank on a tightening of monetary policy.

Is the market pricing in the recovery and the monetary tightening?

A recent strategy note by Morgan Stanley says: “The short-term call is less clear, with the outlook mired by the excessive volatility the market is going through as it grapples with the pace of growth recovery versus the prospects of the central bank tightening both at home and abroad. Other factors such as equity supply, monsoons, and crude oil will also influence share prices. Indeed, the market is pricing in almost all the growth recovery that we are forecasting in the coming six months. However, markets are yet to price in the earnings and industrial growth for FY2011, which bear an upside, according to our view. To that extent, investors with a 12-18 month view are likely to realize positive returns from equities."