In its Asian Development Outlook released on Wednesday, ADB said India's growth is expected to be marginally higher at 6.9 per cent in 2005, which would fall to 6.1 per cent in 2006, only to bounce back to 7 per cent in 2007.

The Manila-based multilateral lending agency expects farm sector to grow by a healthy 4.4 per cent in 2005, even as industrial sector is expected to decelerate to 6.7 per cent while services sector is set to witness 7.7 per cent growth.

ADB said the industrial slowdown in 2005 would be mainly due to ‘cost smoothing’ behaviour of firms to tide over the expected cost escalation as reflected in the latest business confidence survey of India's economic think tank NCAER.

This is corroborated by the fact that firms are very upbeat about capacity utilisation but not optimistic about the demand conditions, it said, noting that the survey showed ‘significant’ proportion of firms are willing to accumulate inventories, especially in consumer goods.

"This explains the beginning of a downturn in industrial business cycle in 2005," it said.

In 2006, it said GDP growth is expected to decline to 6.1 per cent due to further deceleration in the growth of industry and services to 5.2 and 7.3 per cent respectively.

"The revival of industrial and services growth in 2007 will drive up overall expansion to 7 per cent," ADB said.

India has to face medium-term multi-challenges like meeting targets in fiscal responsibility and budget management act, stepping up infrastructure investments, managing rising forex reserves and reinforcing its competitive advantage in textiles and garments since the termination of the multi-fibre agreement, ADB said.

Though it expects a marginal improvement in fiscal deficit of centre and states in 2005-07 through tax reforms, improvement in tax administration and arresting expenditure, ADB said the consolidated fiscal deficit is likely to remain high at above 8 per cent.

Warning that the consolidated revenue deficit is also likely to remain high, it said, "Therefore, it will remain a key challenge for the federal government to increase public investment in infrastructure through additional borrowings, while enduring compliance with the FRBM Act."

This, it said, would be possible only "if adequate fiscal space is created by initiating effective fiscal consolidation measures" and expected the overall investment rate in India to be 27.5 per cent of GDP by 2007.

On the price level, ADB said inflation is expected to decline to 4.2 per cent in 2005, which is considerably lower than 6 per cent in 2004.

Expecting inflation to fall further to 3 per cent in 2006, but only rise to 3.5 per cent in 2007, it said the moderation would be largely attributed to expected stability in prices of fuel and manufactured goods through 2007.

"The downside risks that could undermine the inflation projections include a weak monsoon and a sharp rise in global oil prices," it said.