India's factory output grew by 3.3% in July, the slowest in 21 months, mirroring signs of an imminent industrial slowdown as rising input costs and costlier borrowing squeeze corporate profitability, forcing them to defer investments.
The manufacturing sector, which accounts for 80% of the Index of Industrial Production (IIP), grew only by 2.3%, latest data showed on Monday.
But it is the capital goods sector - whose output contracted by 15.2% - is likely to have the Reserve Bank of India and government policymakers worried.
A slew of fiscal and monetary measures to curb inflation failed to tame prices, but has cast a shadow on growth and investments.
Companies are putting off capacity expansion plans, and costlier borrowing is affecting construction output. At R35.4 lakh crore, investments in new projects by the Indian industry dropped by 35% during the April-June quarter.
Worse, food inflation is still near double-digit levels. fanning prices of manufactured products. India's overall inflation stood at 9.22% in July.
The RBI, which will present its mid-quarter monetary policy review in September, has raised interest rates by 11 times in the past 16 months to cool prices and experts said the central bank may not be done yet with the hikes despite strong signs of slowdown in the domestic economy.
A higher repo raises banks' borrowing costs, which in turn increases interest rates on final home, auto and corporate loans
Economists expect the RBI to raise rates further after factoring in the hike in fuel prices announced last month, but the government wants the central bank to announce a pause in its rate hike cycle.
"We have to seriously look at whether we should stick to the policy we have used, which is the very standard policy or begin to think out of box," said Kaushik Basu, chief economic advisor. "There is liquidity tightening taking place that is also probably having an impact."