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India Factory Output Unexpectedly Shrinks as Rupee Slides

Trucks make their way through traffic in India
Trucks make their way through traffic on a road in Bangalore. India’s failure to upgrade its 4.2 million kilometers of roads, close a 10 percent power deficit and ease congestion at ports is hobbling the central bank’s efforts to beat inflation. Photographer: Namas Bhojani/Bloomberg

Indian industrial production unexpectedly contracted in March as weaker domestic demand and tumbling exports hurt the economy, undermining the central bank’s efforts to shore up a sliding rupee.

Production at factories, utilities and mines declined 3.5 percent from a year earlier, the Central Statistical Office said in a statement in New Delhi today, compared with a 4.1 percent increase in February. The median of 32 estimates in a Bloomberg News survey was for a 1.7 percent gain.

The report may stoke concern India’s outlook has worsened because of trade and fiscal deficits, political gridlock, elevated inflation and the threat to global growth from Europe’s debt crisis. The risks have pushed the nation’s currency toward a record low, prompting the central bank to say yesterday exporters must convert half their foreign-currency earnings into rupees as it stepped up efforts to check the decline.

“The contraction in output data reconfirms weakening demand both domestically and externally,” said Radhika Rao, an economist at Forecast Pte in Singapore. “Even though growth is slowing, from the policy perspective, the focus will be more on inflation, especially due to the impact of the huge decline in the rupee on prices.”

The currency weakened 0.4 percent to 53.635 per dollar at the close. It is down 16.7 percent in the past year, the most in Asia. The BSE India Sensitive Index slid 0.8 percent. The yield on the 8.79 percent note due November 2021 rose one basis point, or 0.01 percentage point, to 8.57 percent.

Interest Rates

The central bank lowered interest rates last month for the first time since 2009, by 50 basis points to 8 percent, to bolster spending at home. It also flagged price pressures from the fiscal deficit, energy costs and a weaker rupee.

“We are in a scenario where the tendency for interest rates is going to be downwards,” central bank Deputy Governor Subir Gokarn said in the southern Indian city of Bangalore today. “The pace and the magnitude is obviously going to be determined by how inflation goes but the direction is now fairly evident.”

The deputy governor also said the monetary authority will continue to try and curb volatility in the rupee.

Manufacturing contracted 4.4 percent in March from a year earlier after a 3.9 percent advance in February, today’s report showed. Mining fell 1.3 percent, compared with a 2.7 percent gain in the previous month. Electricity output rose 2.7 percent.

‘Very Bad’

The latest industrial production report is “very bad,” Finance Minister Pranab Mukherjee said in New Delhi today, adding the recovery in investment remains frail.

Inflation, as measured by the benchmark wholesale-price index, moderated to a 29-month low of 6.67 percent in April, according to the median estimate in a Bloomberg News survey ahead of a report due next week.

While the gauge has cooled after the Reserve Bank raised rates by a record 3.75 percentage points from mid-March 2010 to October last year, India still has the highest inflation in the so-called BRIC group of biggest emerging markets that also includes Brazil, Russia and China.

The central bank’s scope to cut interest rates further to boost growth is constrained by the threat of price increases, Ashima Goyal, a member of the bank’s technical advisory committee, said in an interview in Mumbai on May 8.

Reserve Bank of India Governor Duvvuri Subbarao has also cut the amount of deposits lenders must set aside as reserves twice this year by a combined 125 basis points, to 4.75 percent, to ease cash shortages in the banking system.

Asia’s third-largest economy probably expanded 6.9 percent in the 12 months through March 2012, the least in three years, government estimates show. Merchandise exports rose 3.2 percent in April from a year earlier, after shrinking 5.71 percent in March, according to commerce ministry data.

Faltering efforts to liberalize the economy and uncertainty over tax changes have also damaged sentiment. Standard & Poor’s cut India’s credit outlook to negative from stable last month, putting at risk its investment grade status.

Steel production by companies including Tata Steel Ltd., the biggest producer of the alloy, grew 2.3 percent in March from a year earlier, slower than the 4.7 gain in February, the commerce ministry said in an April 30 report.

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