The HSBC Manufacturing Purchasing Managers' Index (PMI), compiled by Markit, fell to 51.0 in September from 52.4 in August but sustained above the 50 mark for the eleventh month. A reading above 50 separates growth from contraction.
The new orders sub-index fell to 51.3 from 54.5, the steepest fall in 18 months, underscoring weak demand, while output in factories fell to a four-month low.
"Responding to the slowdown, firms lowered purchases and trimmed inventories. The rate of cost inflation decelerated sharply and output prices were unchanged," said Frederic Neumann, co-head of Asian economic research at HSBC.
Input prices or the cost of raw materials rose at its slowest pace in 16 months, the survey showed, indicating overall inflation may show signs of cooling in the near future.
Wholesale inflation in India dipped to 3.74 percent in August, its lowest in five years, even as consumer inflation remained high at 7.80 percent. The Reserve Bank of India (RBI) aims to lower retail inflation to 6 percent by January 2016.
Elevated inflation and risks of a spiral in food and fuel prices prompted RBI Governor Raghuram Rajan to keep interest rates unchanged on Tuesday.
However, it cut the ceiling on bonds that must be held-to-maturity by 2 percentage points and expects to complete the process by September 2015.
India's economy has slowed in recent years due to a mix of high interest rates, slumping investments, policy uncertainty and anaemic global growth.
But the landslide win of Prime Minister Narendra Modi's party has fueled hopes of major reforms in infrastructure, labor markets and foreign investment caps in various sectors.
The government has, however, taken only minor steps so far to encourage investments and savings.
"The RBI would rather see growth recovery supported by supply side reforms than through monetary policy stimulus," Neumann added.
Copyright: Thomson Reuters 2014