Industrial output surges in Dec; stimulus unwind likely

India's industrial output grew at its fastest pace on record in December, smashing forecasts, in further evidence of a strong economic recovery that could allow the government to follow the Reserve Bank in withdrawing stimulus.

Friday's data is unlikely to prompt action from the Reserve Bank of India ahead of its April policy review, after a central banker on Thursday played down the chance of an off-cycle move.

Industrial output grew 16.8% in December from a year earlier, well above a revised annual rise of 11.8% in November and higher than analysts' forecast of 12%.

It was the highest reading since April 1995, when the series, which uses 1993-94 as base year, started.

Policy options

The Reserve Bank of India (RBI) is widely expected to raise borrowing rates at its April review after it surprised markets with a stronger-than-expected rise in banks' cash reserve requirements.

"(The) outturn for December is impressive to say the least and will strengthen the hand of the fiscal and monetary hawks in the Reserve Bank and government," Robert Prior-Wandesforde, an economist at HSBC in Singapore, said in a note. "That's not to say an immediate interest rate response is likely."

Analysts say the central bank seems to be concerned about government finances and that the Feb. 26 annual federal budget would influence the course of its monetary policy in future.

But some believe that higher-than-expected government borrowing in the budget might hold off the RBI from raising rates as it would push up borrowing costs.

Earlier this month, Reserve Bank of India Governor Duvvuri Subbarao said the government's gross market borrowing in the fiscal year to March 2011 might be slightly higher than this fiscal year because of redemptions.

Bond yields hit 16-month highs of 7.88% on Thursday on uncertainty about borrowing needs.

Financial markets in India were closed on Friday for a holiday.

In its previous budget, the government had said it intended to cut the fiscal deficit in 2010/11 to 5.5% of GDP from a projected 6.8% for this financial year.

Any large cut in the deficit would be difficult without rolling back fiscal stimulus.

"We are going to see some rollback of fiscal stimulus in the Feb. 26 federal budget," said Rahul Bajoria, an economist at Barclays Capital in Singapore. "The need to support the manufacturing sector through duty cuts is no longer there."

However, the pace of the expansion in factory output may slowdown with the phasing out of fiscal stimulus.

"I am not sure whether this trend will continue," said Montek Singh Ahluwalia, deputy chairman of India's planning commission.

Car sales in January rose nearly a third from a year earlier as customers bought new vehicles ahead of possible tax hikes in the budget.

Growth drivers

Consumer durables goods output continued to surge on the back of fiscal spending, growing an annual 46% in December. Manufacturing production rose 18.5% on year, while capital goods output was up 38.8% and mining rose 9.5%.

"Capital goods are now contributing strongly to the improvement," said HSBC's Prior-Wandesforde.

"This is convincing evidence that the capex cycle has taken a decisive turn for the better and we expect it to be followed by stronger bank lending growth."

Finance Minister Pranab Mukherjee, who expects the economy to grow around 7.75% in 2009/10, said on Friday factory output data reflected the robust health of the economy.