The HSBC/Markit Purchasing Managers Index for the manufacturing industry stood at 48.5 in August, lower from 50.1 in July, indicating an overall contraction.
The latest index reading was the lowest in over four and a half years and the first sub-50.0 reading since March 2009.
"Manufacturing activity contracted in August for the first time since March 2009. This was led by a decline in new orders, especially export orders," HSBC Chief Economist for India and ASEAN Leif Eskesen said.
Since May, the index was barely managing to remain above the crucial 50-mark that divides growth from contraction. But business conditions in the manufacturing sector deteriorated during August for the first time in over four years, with both output and new orders falling at faster rates.
The reading comes close on the heels of the bleak official figure on Friday that showed that the country's economic growth in the April-June quarter has slid to 4.4 per cent, the lowest in past several years.
According to HSBC, amid reports of fragile economic conditions and subdued client demand, new orders placed at Indian manufacturers fell in August. Moreover, new business from abroad also declined, ending an 11-month sequence of growth.
The report further noted that input and output price inflation slowed despite the weakening of the currency, which likely reflect the softening demand conditions and, therefore, declining pricing power.
The rupee had touched an all-time low of 68.80 to dollar on August 28 and is currently hovering around the 66/USD mark in a highly volatile trade.
"Notwithstanding the weak growth backdrop, the RBI will likely keep its liquidity tightening measures in place for a while still to help contain the depreciation of the currency. Combined with the heightened macroeconomic uncertainty, this will continue to weigh on growth in coming months," Eskesen added.