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India's manufacturing activity expanded for a second straight month in May to its highest level in eight months, reflecting a revival in domestic demand, but weak exports are likely to remain a drag on the economy.
Hefty interest rate cuts by the central bank and government stimulus packages have boosted optimism in recent months that a rebound in domestic consumption will pull the economy out of its slowdown faster than economists had expected.
Domestic demand accounts for 85 per cent of India's economy, much higher than its Asian peers such as China, which are far more reliant on exports.
China's manufacturing sector also expanded moderately in May, showing the two big Asian economies were faring much better than their Western counterparts where similar indicators due later on Monday were expected to show deep contractions.
The Markit Purchasing Managers' Index (PMI) based on a survey of Indian 500 companies, rose to 55.7 in May from April's 53.3, well above the threshold of 50 that separates expansion from contraction. It hit a trough of 44.4 in December and has risen steadily since then.
The manufacturing index was boosted mainly by the new orders index, which rose to 59.1 from 54.9 in April.
However, data on Monday showed exports fell by 33.2 per cent in April from a year earlier to $10.74 billion, while imports dropped by 36.6 per cent to $15.75 billion.
Trade Secretary G.K. Pillai said exports would continue to decline until September, when the global economy is expected to be on more solid footing, and forecast total exports of between $168 billion and $170 billion in 2009/10, little changed from the year earlier.
"The picture that is emerging from recent data is some sort of a stabilisation in domestic demand, possibly due to higher government spending and restocking demand," said Sonal Varma, an economist at Nomura Research.
The PMI numbers come after data on Friday showed Asia's third-largest economy expanded faster than expected in the March quarter, boosted by strength in the farm and services sector.
"The pickup in new orders shows that domestic-demand should gather momentum in the coming months," Varma said.
Manufacturing makes up about 15 per cent of India's gross domestic product and industrial output fell 2.3 per cent from a year earlier in March, its steepest annual pace in at least 14 years.
Many analysts have upgraded India's growth projections this year after the Congress party-led coalition was re-elected last month, which could speed reforms. UBS said last week its lead indicator pointed to a recovery in the industrial sector by June.
Macquarie Research said it had raised its growth forecast for 2009/10 to 7 per cent from 5.5 per cent earlier.
The economy grew at 6.7 per cent in the 2008/09 fiscal year, much slower than average expansion of 9.4 per cent in the previous three years to March 2008.
The central bank expects it to expand by about 6 per cent in the current year ending in March 2010. It has slashed its benchmark lending rate by 425 basis points since October to 4.75 per cent to spur growth.
"We believe that the bottom formation of the economy in this cycle is almost complete and the need for (more) aggressive fiscal and monetary policy actions will be limited," ICICI Bank said.
However, although domestic demand improved, the export sector which accounts for 15 per cent of the GDP remained weak, Markit economist Gemma Wallace said.
"Data show that the sector is currently being carried by robust domestic demand, as export sales continued to fall," Wallace said.
Exports have fallen for seventh straight months as recession-weary global consumers cut back in spending.