There’s no doubt that business sentiment has improved since Prime Minister Narendra Modi came to power. There is talk of big investments coming in, the Chinese and the Japanese are eager to get more involved in the Indian market and surveys of business confidence are flying high. As expected, this means that the stock markets have been on a bull run, with many confidently claiming the benchmark Sensex index could hit 30,000 early next year, soaring from the high of 27,354 it touched last week.

But the markets don’t always reflect the economy or vice versa. The latest industrial production numbers suggest the initial cheer that followed Modi’s victory has washed out of the system. The Index of Industrial Production showed that industrial output had slowed to just 0.5% in July, following a couple of strong months before.

The manufacturing numbers for July were particularly troublesome: -1%, against 1.8% growth the month before. Other indicators also suggested that there’s a lot of work ahead. Consumer durables factories saw a contraction of 20% in July over the previous year's numbers, while consumer goods’ output also fell by 7%.

All of this, combined with a stubborn inflation rate, means that ordinary Indians are still being cautious. Investors might be happy with a huge amount of foreign funds flowing into India over the last few months, but their glee has not been infectious. Consumers remain reluctant to part with cash.

Meanwhile, businesses say that they are confident about the economy: the National Council for Applied Economic Research registered a 17% increase in its Business Confidence Index in the quarter ending June over the first quarter of 2014. But the industrial production numbers make it clear that this confidence has yet to turn into a genuine belief that consumer demand is going to pick up.

Inflation is crucial here. Although retail inflation has tempered somewhat, coming down to 7.8% in August from 7.96% the month before, it remains substantially higher than the Reserve Bank of India’s target of 6%. As long as inflation remains high, consumer demand is unlikely to grow tremendously – with an exception for the upcoming festive season – and that will make it harder for RBI to reduce interest rates, which would encourage companies to invest more.

No one was expecting an immediate turnaround, of course, despite the Acche Din promises of the Bharatiya Janata Party's election manifesto. The problems with industrial production are structural and cannot be resolved immediately. The government has set out a plan to overhaul manufacturing and individual states have started making changes to their laws in an effort to improve the business atmosphere, although the utility of these remains to be seen.

Yet the dip in consumer and manufacturing numbers in particular lays out the scale of the challenges that Modi and his finance minister Arun Jaitley face, beyond the immediate task of keeping the stock markets happy. Modi and Jaitley will be looking forward to an improvement in figures as we head into the Diwali festive season, but those will also be the months where the full extent of the delayed monsoon and floods in key agricultural regions will become clear.