NEW DELHI (Reuters) - India's new government got the best news on the economy in a year on Thursday, as industrial growth rebounded and retail inflation dropped to a three-month low - signs of an economic revival that could offset the threat of patchy summer rains.
Output from mines, utilities and factories, recovered from two straight months of contraction to expand 3.4 percent year on year in April, its fastest pace since March 2013, government data showed.
Growth of 1.9 percent was forecast by economists in a Reuters poll, after a 0.5 percent year-on-year decline in March.
India's economy has been dragged down by slumping industry. Industrial production shrank a provisional 0.1 percent in the fiscal year that ended in March, keeping overall economic growth below 5 percent for a second straight year.
Prime Minister Narendra Modi, who took office on May 26 with the strongest parliamentary majority in 30 years, has vowed to engineer a turnaround by stepping up investment and clearing regulatory hurdles for businesses.
"There is some possible improvement in the investment cycle going ahead on confidence building," said Anjali Verma, an economist at PhillipCapital. "This kind of data will encourage the government to take steps to boost growth."
Bureaucratic gridlock coupled with an uncertain tax policy has stymied capital investments. Capital goods, for example, expanded for the first time in five months in April, posting an annual growth of 15.7 percent.
Expectations of an investment-led economic turnaround after Modi's victory have brought in copious capital, sending the total value of the Indian stock market over $1.5 trillion for the first time.
Thursday's industrial production data, coming on the heels of the sharpest growth in merchandise exports in May, are expected to further boost investor sentiment.
Adding to the cheer, a slower annual gain in food prices helped ease consumer price inflation to a three-month low of 8.28 percent in May from 8.59 percent the previous month, another government report showed on Thursday.
Persistently high food prices have made inflation India's Achilles heel, making it tougher for the central bank to lower lending rates even as economic growth sags.
Retail inflation has been above 8 percent since February 2012. The Reserve Bank of India eased rules to spur bank lending and toned down inflation rhetoric at its last policy review, but few analysts expect it to cut rates anytime soon.
"We do not think policymakers will be minded to loosen policy just yet," said Mark Williams, chief Asia economist at Capital Economics.
Stubbornly high inflation and elevated interest rates have curbed consumer demand, which powers more than half of Asia's third-largest economy. Consumer goods output, a proxy for consumer demand, has grown just once in the past 12 months. In April, it contracted 5.1 percent from a year earlier.
Modi's government has promised to break the "vicious" cycle of high inflation and high interest rates by reforming the agriculture market and improving the supply chain. But those measures will take months to produce results. Meanwhile, below-average monsoon rains look increasingly likely, which could exacerbate price pressures.
New Delhi has stockpiled staples such as rice, wheat and sugar from bumper harvests in the past few years, but it has limited control over the cost of fruits and vegetables, which has the largest impact on food inflation.
"The key risk is ... El Nino's impact on food (prices)," said Shubhada Rao, the chief economist at Yes Bank. She reckons bad summer rains could push up headline retail inflation as much as 70 basis points.
(Additional reporting by Neha Dasgupta and Suvashree Dey Choudhury in Mumbai; Editing by Larry King)
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