Oct industrial output contracts, builds case for rate cut

NEW DELHI (Reuters) - India's industrial output contracted in October, its worst performance in three years, while retail inflation continued its declining trend, building the case for the Reserve Bank of India to lower interest rates early next year.

Prime Minister Narendra Modi, who swept to power six months ago promising to oversee an economic revival, faces a challenge to revive investment in Asia's third largest economy.

He has been helped by a fall of more than 40 percent in global crude prices since July which has brought inflation down, lowered the import bill and reduced government spending on fuel subsidies.

Industrial output unexpectedly contracted 4.2 percent year-on-year in October, dragged down by a fall in manufacturing and the capital goods output, government data showed on Friday.

"The IIP (industrial output) was shocking, I think there's probably a one-off factor," said Shivom Chakrabarti, senior economist at HDFC Bank in New Delhi. "Overall, it does highlight the fact that growth is still weak and inflation pressures are falling.

"It does put more pressure on the RBI to cut rates but I think given the guidance RBI has provided, it would be prudent for it to wait at least until February."

Analysts polled by Reuters had forecast that output would grow 2.80 percent and retail inflation at 4.5 percent.

Retail inflation, which the RBI tracks to guide its interest rate policy, slowed to 4.38 percent in November, helped by falling fuel and food prices.

With growth struggling at 5.3 percent in the July-September quarter, it is likely to be some time before the country recaptures the 8 percent growth levels needed to create enough jobs for a rapidly expanding workforce.

Reserve Bank of India Governor Raghuram Rajan, who left policy interest rate unchanged this month, said on Friday the RBI would start talks with the government for an appropriate timeline to ensure the economy is within a medium-term inflation target of 2-6 percent.

While not as low as China's, India's inflation has come down steeply from over 11 percent in November last year, and is now lower than other BRICS economies - Brazil, Russia and South Africa.

Finance Minister Arun Jaitley, who will present the annual budget in February, told parliament on Wednesday a rate cut would help the economy, singling out prospects of increased mortgage lending.

(Reporting by Manoj Kumar; Editing by Douglas Busvine and Robert Birsel)