New Delhi: India’s industrial production expanded less than expected in August in further evidence of a slowdown in Asia’s third-largest economy as soaring interest rates and persistently high inflation weigh on demand.

The 4.1% growth in August industrial output over the previous year lagged a Reuters poll forecast for 5% growth and was only a slight improvement on the revised 3.84% growth clocked in July.

A man working in a wooden toy factory at Mayapuri in New Delhi. (File photo / Ramesh Pathania)

Whether that persistent weakness in industry will spur the central bank into ending a long cycle of rate rises may be determined by Friday’s inflation data.

With the inflation rate hovering near its highest in more than a year, the RBI, one of Asia’s most hawkish central banks, is in no hurry to relax its tight policy stance.

Indeed, while most emerging market central banks have either cut rates or abandoned their anti-inflation campaigns as the outlook for global growth worsens, India’s central bank has signalled it will persist with its fight against rising prices.

RBI deputy governor Subir Gokarn made clear on Wednesday the policy stance would shift only when inflation pressures eased.

“The industrial production number is slightly below expectations but what matters for the RBI is inflation," said Kumar Rachapudi, a strategist at Barclays Capital in Singapore.

“The RBI’s statements have been hawkish and clearly hinting that inflation is still the priority. Base case has been for no hike on 25 October, but the probability of hiking has increased a lot."

Inflation was nearly 9.8% in August, the highest rate in more than a year. A Reuters poll this week forecast September inflation, due on Friday, will be just slightly lower at 9.70%.

The main policy rate is lower than that level, at 8.25%. Besides, with exports just a meagre contributor to the primarily domestically driven economy, India can with good reason afford to focus on its number-one priority: inflation.

“We raise rates not because it is an end in itself," RBI’s Gokarn said, addressing students in Jaipur.

“To the extent we see the problem persisting, then there is a basis to raise rates but if we see the problem is starting to ease off, then that would provide the basis for a change."

Signs of weakness

Industrial output continues to lag broader economic growth in India, which slowed to 7.7% in the April-June quarter, its softest in six quarters, while manufacturing growth was the weakest in two-and-a-half years.

This mirrors a worldwide trend of stalling factory activity and a worryingly weak pace of new orders, symptoms of faltering US growth, the euro zone debt crisis and the impact those are having on business and consumer sentiment.

India, which is largely driven by domestic demand, is relatively more insulated from the global turmoil. But that may not be for long.

On Monday, an industry body cut its sales growth target for cars in this fiscal year to 2-4 percent, a sharp drop from the 30% growth clocked in the previous year.

Infrastructure sectors such as coal and cement, key to India’s growth and contributing about 38% to the index of industrial output, grew just 3.5% in August, the slowest pace since November 2010.

The HSBC Markit India Manufacturing PMI fell closer to the 50 mark that divides growth from contraction in September, sinking to its lowest reading since March 2009 at 50.4, indicating slowing output and orders growth.

Exports in August rose 44% to $24.3 billion from a year earlier, almost half the growth clocked in July, indicating headwinds that Indian exporters are facing from the global fragile growth situation in United States and the eurozone. India’s trade secretary said on Wednesday September exports would be around $24.8 billion.

In August, the capital goods sector grew 3.9% after contracting almost 14% in July. This data is known to be volatile however, and the rebound may not indicate an industrial recovery.

Manufacturing output , which constitutes about 76% of the industrial production and less than a fifth of economic output, rose an annual 4.5% in August.

Not Enough For RBI

However, that may still not be enough for the RBI to rethink its policy.

In its 16 September review, India’s central bank had said that a premature change in the policy stance could harden inflationary expectations, diluting the impact of past policy actions.

Its next rate decision is on 25 October. A Reuters poll last month found that economists expect one more interest rate increase in 2011, which would make India an outlier in a world where most central banks are looking to stimulate growth.

Pakistan cut rates last week, Indonesia did likewise in a surprise decision on Tuesday.

India’s 10-year bond yield jumped 2 basis points to 8.73% after the data release.