NEW DELHI (Reuters) - Factory output fell for the third time in four months in January, supporting the case for further cuts in interest rates as government and central bank action to lift a sagging economy kick in slowly.
Industrial production fell an annual 0.5 percent in January, only marginally better than the previous month's 0.6 percent contraction, while inflation eased to 2.34 percent at the end of February, renewing talk of monetary easing.
"Against this background, a further 50 basis point rate cut from the Reserve Bank can't be ruled out and could even come ahead of the general election which kicks off in mid-April," HSBC economist Robert Prior-Wandesforde said in a note.
The Indian economy is largely driven by domestic demand, unlike many other Asian economies which depend on exports. But expensive credit and the global slump have dented confidence at home and slashed overseas sales of Indian goods.
Economists said aggressive monetary easing by the Reserve Bank of India (RBI) since October and government stimulus would only help factory output recover later in the year.
"The number was largely in line with consensus and there were no negative surprises. The February number might be positive but we expect a negative number in March," said Atsi Sheth, chief economist at Reliance Equities, in Mumbai.
"Today's number reflects both the global slowdown and the RBI's tightening in the first half of 2008. The effects of the easing policy and the fiscal stimulus packages will be apparent only after August 2009."
Car sales, an important measure of consumer demand, snapped a four-month slide in February, up 22 percent from a year earlier after banks cut loan rates and carmakers passed on the benefits of duty cuts to consumers.
But analysts said the data did not signify a turnaround in sentiment.
With national elections to be held in April and May, the ruling Congress party-led coalition could suffer if the slowdown results in further large job losses.
It had hoped to trumpet an economy which had been racing along at 9 percent growth rates for the last three years but is now facing headlines of layoffs and falling revenues.
January's contraction in factory output was just below a forecast for a decline of 0.4 percent from a year earlier in a Reuters poll of economists.
Manufacturing production fell 0.8 percent. Exports dropped an annual 16 percent in January.
Inflation data released on Thursday showed India's wholesale price index rose 2.43 percent in the 12 months to Feb. 28, below the previous week's annual rise of 3.03 percent.
The benchmark stock index extended gains to 3 percent after the industrial output data was released, and ended 2.25 percent higher.
The rupee remained largely steady after the data, but the yield on the benchmark government bond maturing in 2018 ended higher at 7.17 percent from Monday's close of 6.84 percent, as investors braced for heavy supplies and absorbed the weak output data.
Industrial output growth has slowed sharply from annual rates above 10 percent in 2006 and the first half of 2007. In October, provisional data showed factory output contracted for the first time in 13 years, and fell an annual upwardly revised 0.6 percent in December.
Since October, the central bank has cut its key lending rate by 400 basis points, while the government has slashed factory gate duties and service tax to protect growth and jobs.
In the December quarter, the economy expanded 5.3 percent, its slowest pace in almost six years.
Authorities now say growth in Asia's third-largest economy is likely to slow to around 7 percent in the current fiscal year to March 2009.
But analysts say growth could be even lower, and expect wholesale price inflation to drop further to between 1.5 and 2 percent by March-end.
Additional reporting by C.J. Kuncheria and India Treasury