By Rajesh Kumar Singh

NEW DELHI, Jan 11 (Reuters) - India's industrial output unexpectedly shrank in November, and while the data was badly distorted by the Diwali holiday it was still seen backing the case for an interest rate cut to boost an economy that appears set to post its slowest growth in a decade.

The index of industrial production fell 0.1 percent annually in November, data released by the Central Statistics Office showed on Friday, compared with revised growth of 8.3 percent in October. Output has grown in just three of the last eight months.

The outturn was even worse than the 0.7 percent growth a Reuters' poll of analysts had predicted for November.

Output was depressed by the Diwali holiday, which was in November last year, whereas in 2011 it fell in October. Diwali is one the biggest Hindu festivals in India, with many factories shutting for several days.

'The correction in the November headline (industrial production) was largely priced in on passage of festive demand and manufacturers' possibly drawing down on inventories rather than stepping up production towards end-2012,' said Radhika Rao, economist at Forecast Pte, Singapore.

Still, Friday's data underscores the challenge Prime Minister Manmohan Singh faces turning the wheel on the economy.

GDP growth that once looked set to hit double-digits has been stuck below 6 percent for the past three quarters. The slowdown is worrying for the government as it prepares for a series of state elections and a general election due in 2014.

December trade data due out later on Friday could add to the misery, as exports, which make up around one-fifth of the economy, have fallen against year ago in the previous seven months.

To revive investments and salvage a reputation made as the architect of India's economic liberalization in 1991, Singh has launched a slew of bold measures since late last year that included cutting fuel subsidies, hiking rail passenger fares and opening the retail sectors to foreign players.

Capital goods production, however, shrank an annual 7.7 percent in November. The sector, seen as a guide to investment levels, has grown just once in the last eight months.

'The contraction in capital goods after a brief reprieve last month reiterates that investment cycle is yet to pick up in a meaningful manner,' Shubhada Rao, Chief Economist at Yes Bank, in Mumbai.

RATE CUT IN OFFING?

Politicians and businessfolk have been calling for the central bank to slash interest rates that are among the highest of the major economies.

The Reserve Bank of India (RBI) has left its policy repo rate unchanged at 8.0 percent since April 2011, citing stubbornly high inflation, but has signalled it could cut in the January-March quarter and eyes are now on an upcoming policy review on Jan. 29.

Inflation numbers for both wholesale and retail prices are due to be released on Monday and should provide crucial pointer.

According to a Reuters poll of analysts, wholesale prices probably rose an annual 7.40 percent in December, faster than a 7.24 percent rise in the previous month.

Consumer price inflation in the same month probably stood at 10.20 percent, above 9.90 percent in November, the same poll showed on Thursday.

Several analysts believe the RBI should still have leeway to cut its policy rate if the uptick in inflation in December is not more severe, as inflation had been slowing in the previous two months.

'We are of the view that the Reserve Bank of India will definitely cut rates by 25 basis points, maintain a dovish tone, and a commitment to maintain liquidity in the comfort zone through open market operations,' said Rao of Yes Bank.

(Editing by Simon Cameron-Moore) Keywords: INDIA ECONOMY/OUTPUT

(rajeshkumar.singh@thomsonreuters.com)(+91-11-4178-1056)(Reute rs Messaging: rajeshkumar.singh.thomsonreuters.com@reuters.net)

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