The HSBC Services PMI, compiled by Markit, fell to a three-month low of 47.5 in March from 48.8 in February, chalking up its ninth straight month below the 50-mark that separates growth from contraction.
"Following some stabilization in recent months, service sector activity weakened again in March led by softer domestic demand," said Leif Eskesen, chief economist for India & ASEAN at HSBC.
New business fell at a faster pace - the sub-index was at 47.6 in March, down from February's 49.5.
Still, firms increased headcount for the fourth month after building up a small amount of outstanding business and were the most optimistic about the future than they have been since July.
That optimism could be in anticipation that an upcoming election will usher in a new government led by the opposition Bharatiya Janata Party, which is perceived to be more business-friendly.
Persistently high inflation has pushed the central bank to increase interest rates three times since September, although price pressures eased in February.
The Reserve Bank of India kept its main refinancing repo rate unchanged this month after inflation dipped and the Governor cited a downward risk to his growth estimate of 5-6 percent this fiscal year.
"Growth is expected to remain subdued in coming months, but pick up gradually during the second half of 2014. This, however, assumes that the election outcome provides the elected government with a workable mandate," Eskesen said.
Indian manufacturing activity grew at a slower pace in March as weaker domestic demand dragged on output growth, a similar business survey showed on Tuesday.
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Private sector output in India falls in March: HSBC
(PTI) Private sector output in India fell in March, after a fractional increase in the previous month amid moderation in domestic demand conditions, an HSBC survey said today.
The HSBC India Composite Output Index, which maps both services and manufacturing, declined from 50.3 in February to three-month low of 48.9 in March, as manufacturing production growth eased and service sector activity fell at faster rate during the month.
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Meanwhile, the HSBC services business activity index fell from 48.8 in February to 47.5 in March, remaining below the 50 level mark for the ninth successive month.
A PMI reading above 50 indicates growth while a lower reading means contraction.
The contraction in the services sector activity was largely on the back of softer domestic demand. New business received by Indian services companies decreased for the ninth month running in March.
According to the HSBC survey, the weaker client demand, that led to the latest drop in new work intakes, can be partly linked to the forthcoming elections,
"Following some stabilisation in recent months, service sector activity weakened again in March led by softer domestic demand," HSBC Chief Economist for India & ASEAN, Leif Eskesen said.
However, Indian service providers were optimistic that activity would rise over the next 12 months as growth of new business, supported by improved economic conditions and new marketing initiatives, is expected to drive the expansion.
On price rise, the report said inflationary pressures in the Indian private sector softened during March, with both input costs and output prices rising at weaker rates.
Looking ahead, growth is expected to remain subdued in coming months, but pick up gradually during the second half of 2014, Eskesen said adding "this, however, assumes that the election outcome provides the elected government with a workable mandate".
India's economic growth slowed to 4.5 per cent in 2012-13 due to the global slowdown and domestic factors such as high interest rates.
The growth rate during April-September of 2013-14 slipped to 4.6 per cent from 5.3 per cent in the same period in the previous financial year.