New Delhi: India’s factory output showed signs of moderation, growing slower than expected in May as companies dissolved their inventory amid capacity constraints. With the favourable base effect having ended in May, growth in industrial production may see further moderation in the June figures.

Graphic: Paras Jain/Mint

The index of industrial production (IIP) grew at 11.5% in May compared with 2.1% a year ago, the eighth straight month of double-digit growth. The median forecast in a Reuters poll was for 16% growth. The Central Statistical Organisation,?which releases the data, revised the growth rates for February and April downward.

“Nobody should expect that industrial manufacturing sector will continue to grow at abnormally high numbers for a long time to come," finance secretary Ashok Chawla told reporters. “There are capacity constraints. Whatever output lag there was in the economy has been filled."

While there was slowing across most sectors, the most dramatic was that of capital goods to 34.3% from 69.9% in April.

The benchmark Bombay Stock Exchange Sensitive Index (Sensex) rose for the third session in a row, closing at its highest in more than three months on Monday, riding a wave of earnings optimism as the season kicks off this week. The 30-share index closed 0.58% or 103.66 points higher at 17,937.20 points.

“IIP grew at a lower-than-expected rate due to relatively slower growth in capital goods. This is due to its lumpy nature," said Shubhada Rao, chief economist with Yes Bank Ltd. “However, there is no cause of worry at this point of time as IIP is only undergoing correction and underlying growth fundamentals remain strong."

Rao expects IIP to grow 9.5-9.8% in the current fiscal ending March 2011. CitiIndia economist Rohini Malkani echoed this sentiment.

“We see no need for undue concern as data trends both at the macro (loan growth, non-oil imports) and sectoral front (auto, cement, diesel consumption) are healthy," she said in a research note.

“We were expecting the numbers to moderate from June due to a fading base effect, but May data indicates that the moderation has already begun. This is reflected across segments though it is more prominent in capital and consumer goods," she added.

CitiIndia maintained its earlier gross domestic product growth forecast of 8.4% for the current fiscal. While the government expects growth to remain within 8.5% for the fiscal, the International Monetary Fund last week said that India’s economy would accelerate at 9.4% in 2010 on the back of robust corporate profits and favourable financing conditions.

Sectors such as manufacturing, mining and electricity grew at 12.3%, 8.7% and 6.4%, respectively, significantly decelerating from their April levels. Fifteen out of the 17 industry groups showed positive growth, except wood products and beverages.

While the production of consumer non-durables remained sluggish in May, growing at 2.4% due to high inflation and weak agricultural production, consumer durables continued to be robust, surging at 23.7%. “Low interest rates, high consumer confidence and improving labour market conditions have supported strong growth in consumer durables," Nikhilesh Bhattacharyya, associate economist at Moody’s, said in an advisory note.

The Reserve Bank of India (RBI) is unlikely to change its monetary tightening course, economists said. “The central bank at present is focusing on inflation management and it will continue to do so," said Yes Bank’s Rao. “RBI will continue to tighten monetary policy though the extent of increase will be gradual. We expect another 25 basis points of rate hike in the policy review later this month."

A basis point is one-hundredth of a percentage point.

“We maintain our view of further rate hikes of 50 basis points in 2010, and given our expectations on June inflation (10.2%), we expect a 25 basis points hike in the (RBI) policy meeting on July 27," said Malkani of CitiIndia.

Federation of Indian Chambers of Commerce and Industry secretary general Amit Mitra said in a statement that RBI should be cautious before announcing any measure that would “further hurt or discourage sentiments in manufacturing sector".

RBI raised its key policy rates on 2 July for the third time this year by a quarter percentage point three weeks ahead of its quarterly policy review to fight rising inflation, citing strong underlying growth momentum. Monthly wholesale price inflation crossed 11% in March and stood at 10.16% in May, according to provisional data released by the government.

Reuters contributed to this story.