Manufacturing sector grew at its fastest pace in five months in March, marking the third straight month of expansion, on strong surge in domestic and export orders, a monthly survey showed on Monday.

The survey also showed that the inflationary pressure eased in the sector as input prices rose at a slower pace and the corresponding easing of output prices helped boost demand.

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The Nikkei Markit India Manufacturing Purchasing Managers' Index (PMI) — an indicator of manufacturing activity — increased to a five-month high of 52.5 in March, from 50.7 in February.

A reading above 50 indicates expansion, while any score below the mark means contraction.

The factory output grew fast as order books expanded at the quickest pace since the demonetisation move, which had hit the manufacturing as well as services sector hard in a largely cash-dependent economy.

This is the third consecutive month of expansion in the manufacturing sector after the demonetisation-induced contraction during November-December period.

"PMI data for March reveal positive developments in the Indian manufacturing sector. Rates of expansion in factory orders and production accelerated again, encouraging some companies to scale up their input buying and take on additional workers," said Pollyanna De Lima, Economist at IHS Markit and author of the report.

On the prices front, the report said although both input costs and output charges rose further, inflation rates softened from February. During March, the rate of inflation slowed to the weakest in four months and was below the long-run survey average.

"Given that input costs rose at a softer pace, a whopping 96 per cent of goods producers kept their selling prices unchanged over the month," Lima added.

The Reserve Bank in its policy review meet on February 8 kept key interest rate unchanged at 6.25 per cent and said it is awaiting for more clarity on the inflation trend and impact of demonetisation on growth.

The next meeting of the MPC (Monetary Policy Committee) is scheduled this week for April 5-6, 2017.

Going ahead, the survey painted a bullish outlook as business confidence among manufacturers improved in March, with almost one-fifth of panelists expecting output levels at their units to be higher in 12 months' time.

Lima said production volumes are likely to rise further as businesses will seek to replenish their stocks.

"Indeed, we saw a marked drop in inventories of finished items, alongside a stronger degree of confidence towards the year-ahead outlook for output," she added.

Commenting on the PMI data, Capital Economics' India economist Shilan Shah said the latest figures affirm that the economy is on a firmer footing after the hit to activity from demonetisation.

"Looking ahead, manufacturers should continue to recover over the near term, but the sector still faces bigger structural constraints," Shah said in a note.

"Looking ahead, we expect domestic demand to recover gradually as new Rs 500 and Rs 2,000 notes become more widely available and also as more people switch to digital payments.

This should boost the near-term prospects for manufacturers," he added.

At the same time, the longer-term outlook depends on the government's reform agenda, the economist said.

"… While the government's political capital has increased, there is no clear indication that Prime Minister Narendra Modi actually has the conviction to push ahead with necessary but unpopular reforms that would boost manufacturing, including on the labour market and land acquisition. For now at least, a sustained pick up in manufacturing seems unlikely," he added.