Indian industrial output grew at its slowest rate in six years in May, but a jump in inflation to nearly 12 percent dashed any hopes that weakening growth could persuade the central bank to hold off with interest rate rises.
The central bank's tightening campaign to tame price pressures stoked by soaring oil costs bit into consumption and capital goods production in the $1 trillion economy, casting doubt over official forecasts for 8.0-8.5 percent economic growth this fiscal year.
But economists saw no respite on rates even after two increases in June, given that inflation has more than tripled over the past sixth months, raising the spectre of a backlash against the government at elections due by May 2009.
"The slowdown is across the board with both consumer and capital goods much weaker than expected," said Sonal Varma, economists at Lehman Brothers in Mumbai.
"Slowing growth and rising inflation adds to the monetary policy dilemma," she said, adding she expected the central bank to raise its key lending rate from 8.5 percent later in July.
The benchmark stock index fell sharply after the output data, bringing the day's losses to more than 2 percent. The 10-year bond yield edged down 2 basis points to 9.42 percent, in a sign the market judged the central bank might now be only slightly less aggressive than anticipated with future policy tightening.
Industrial output rose 3.8 percent in May from a year earlier, sharply less than previous month's downwardly revised 6.2 percent and well below forecasts for 7.2 percent. It is the slowest rate of growth since March 2002.
Manufacturing production rose 3.9 percent in May from a year earlier and capital goods output growth slowed to 2.5 percent annually, compared with a fierce 22.4 percent a year ago.
The output data coincided with the release of the wholesale price index, India's most widely watched inflation measure, which rose 11.89 percent in the 12 months to June 28. The rise was the highest since annual numbers in the current series became available in April 1995, outstripping the previous week's annual rise of 11.63 percent and the market's 11.75 percent forecast.
As well as raising interest rates, the central bank has jacked up banks' reserve requirements as part of its campaign to stamp out knock-on price increases expected from a 10 percent rise in administered fuel prices in June.
Robert Prior-Wandesforde, an economist at HSBC in Singapore, said the central bank was less concerned about growth than inflation, which he thought would hit 15 percent later this year. Accordingly, he expected the monetary authority to raise both interest rates and banks' reserve requirements again at a policy review this month.
International rating agency Standard & Poor's said on Friday India's credit profile had worsened in the past year due to higher inflation and growing fiscal and current account deficits and the risks to its BBB- investment grade rating were increasing.
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