The weakening manufacturing sector can further hurt economic recovery

Indian manufacturing activity contracted in December for the first time in more than two years, hurt by softening domestic demand, adding pressure on the central bank to ease policy, a business survey showed on Monday.

Nikkei's Manufacturing Purchasing Managers' Index, compiled by Markit, fell to a 28-month low of 49.1 in December from November's 50.3.

It was also the first reading below the 50 threshold that separates growth from contraction since October 2013.

"India's manufacturing sector took a turn for the worse at the year-end, with already gloomy internal demand further hampered by floods in the south of the country," said Pollyanna De Lima, economist at Markit.

Severe rainfall and flooding caused widespread destruction in late November and early December, constraining output to its lowest since the global financial crisis.

The output sub-index fell to 46.8 from 50.4 the previous month, its lowest since early 2009, as new orders fell for the first time in more than two years.

Weak growth will likely harden expectations that the Reserve Bank of India will ease policy further by June, provided inflation is under control.

Inflation has remained within the RBI's January target range of 2-6 percent, giving room for the central bank to shave 125 basis points from rates in 2015. After four moves, the benchmark rate currently sits at 6.75 percent.

But the survey showed output prices continued to rise, driven by higher input costs.

The survey further noted the decline in manufacturing sector production was largely owing to a contraction in incoming new work for first time since October 2013.

Around 18 per cent of survey panelists reported lower levels of new orders, which they commonly linked to heavy rains weighing on domestic demand.

"The continued depreciation of the rupee against the US dollar pushed inflation higher, with PMI price indicators pointing to stronger increases in both input prices and output charges," Lima said.

Given a sharp deterioration in manufacturing output in China as well, the experts believe that the global headwinds can make things even worse for the Indian markets, which will add to the pressures on RBI to keep rates low.

The central bank is scheduled to hold its next monetary policy review next month, although three out of four rate cuts last year were effected outside the planned reviews.

Following the US Fed rate hike and expectations of further increases, more currency weakness is anticipated, which in turn would add strain to businesses' dollar-priced debt and import costs, Lima said.

The frail rupee boosted growth of new business from abroad, but corporate earnings can't solely rely in external markets as global demand remains subdued, he added.

The weakening manufacturing sector can further hurt economic recovery, as the government has already lowered its economic growth forecast for 2015-16 to 7-7.5 per cent from 8.1-8.5 per cent.

Agencies