NEW DELHI (Reuters) - India's economy extended its long slump in the last quarter, with lower-than-expected growth keeping it on track for its worst year in a decade and underscoring the urgency of politically difficult reforms to spur a revival.
Gross domestic product (GDP) grew 5.3 percent from a year earlier in the July-September period, provisional government data showed on Friday, below the 5.5 percent posted for the three months ending in June.
Reacting to the number, Prime Minister Manmohan Singh's chief economic advisor forecast full year growth of between 5.5 and 6 percent, which would be the slowest since 2002/3.
"It will be between the two, because in order to get 6 percent we really need very strong growth in the second half," advisor C. Rangarajan told TV network CNBC.
The number was lower than a Reuters poll had forecast and matched the January-March quarter, which was the weakest growth rate in three years. However, economists say ongoing inflation worries mean the Reserve Bank of India (RBI) is not likely to cut interest rates at its next policy meeting on December 18.
Facing the prospect of the downturn stretching into a general election due in 2014, Prime Minister Singh launched some of the most daring initiatives of his tenure in September, including raising subsidised diesel prices and opening sectors like supermarkets to foreign players, triggering a market rally.
But the government and economists warn more needs to be done to attract capital investment and kickstart plans to modernize India's decrepit infrastructure. Opposition parties say the reforms hurt the common man and weaken regional governments.
"Even with the uptick in business sentiment over the restarted reform initiative, the real economy will take some time to improve. Investment will continue to lag," said Jyoti Narasimhan, Senior Principal Economist, at IHS Global Insight.
India is battling weak consumer demand in overseas and domestic markets. The rupee currency remains weak and the trade deficit the widest ever after merchandise exports, which make up about 10 percent of GDP, fell for six straight months. Industrial output has contracted in four out of last six months.
Market reaction to the data was muted, partly because of sustained positive sentiment after parliament broke a deadlock on Thursday that had held up debate on reforms to attract foreign investment in the insurance and pension industries. Mumbai's main stock index .BSESN hit a 19-month high.
"Domestic markets held on to gains as the Q3 GDP was along expectations," said Radhika Rao, an economist with Forecast in Singapore. "Progress on reforms and proper functioning of the parliament will be important in shaping sentiments further out."
Markets were also buoyed by a mildly upbeat view from Goldman Sachs on Thursday, with a report forecasting India's economic growth was likely to accelerate to 6.5 percent in 2013.
"A DIFFICULT SITUATION"
Growth was dragged down by subdued manufacturing output growth of 0.8 percent on the year and farming output of 1.2 pct.
Finance Minister P. Chidambaram last week warned that India faced a "a difficult situation" and needed innovation to boost output. He has pressured the RBI to cut rates.
"Monetary policy stance of the Reserve Bank of India to contain inflation has impacted industrial production partly through increase cost of borrowing and lower domestic investment," Chidambaram said in a written reply to a question in parliament on Friday.
Worryingly for hopes of a quick rebound, capital goods production -- a gauge of investment in the economy -- has expanded just once in the last 13 months.
India's benchmark 5-year OIS rate barely moved on the data and the rupee rose slightly.
Low growth is making it harder for Chidambaram to rein in a wide fiscal deficit, which global ratings agencies say needs to be controlled if India is to avoid losing the investment grade designation on its sovereign debt.
In a major relief to the government on Tuesday, rating agency Moody's reaffirmed its stable outlook on India. Rivals Fitch and Standard & Poor's are expected to reveal their thinking by March.
A growth rate below 6 percent for the third quarter in a row is damaging for a country that aspires to at least 8.5 percent expansion to provide jobs for its burgeoning population, and makes it tougher for Singh to fund flagship welfare programmes.
Singh is fighting to defend his reforms in parliament, where a non-binding vote on the supermarket policy will be held on Wednesday. The outcome may test the minority government's appetite for further reforms ahead of a string of state elections starting in December.
The government says India needs to take more steps quickly, including speeding up approval for infrastructure projects, overhauling the tax system and reducing its swollen deficit to revive capital investment.
The RBI has said any interest rate cut is "highly improbable" at the December 18 meeting. The low number raised expectations of some monetary loosening, however.
"The growth is below the Reserve Bank of India's trend growth expectation, and I think the central bank will cut rates further from here," said Robert Prior-Wandesforde, Director, Asian Economics Research at Credit Suisse in Singapore.
"I expect a repo rate cut in January and there could possibly be another cash reserve ratio cut in December."