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* Diesel demand to grow at slowest rate in three years
* Demonetisation effects in Q1 to drag down annual growth
* Fuel efficiency, power substitution dent growth rate
By Jessica Jaganathan
SINGAPORE, May 30 (Reuters) - India's diesel demand is expected to rise to record levels again this year as a slew of infrastructure projects boosts use of the transport and industrial fuel, although a government-induced cash shortage will hold growth to its slowest in three years.
Increased fuel efficiency, a fall in commercial vehicle sales, and the use of other fuels for power generation are also expected to dent demand growth for diesel, analysts and traders told Reuters.
"The first quarter saw delayed effects of demonetisation but I think (diesel demand) should improve as there are a number of projects going on such as road and railways, which should drive diesel demand up," said Tushar Bansal, director of Ivy Global Energy, a Singapore-based consultancy.
India has budgeted a record $59 billion for 2017/18 for infrastructure such as ports, roads, railways and power.
The world's third largest oil consumer guzzled 6.955 million tonnes of diesel in April, the highest so far this year and near a record of 6.958 million tonnes hit in May 2016, the latest government data showed.
Still, a weak first quarter is expected to hold India's diesel demand growth at 1.6 to 3 percent this year, a gain to 1.63 million to 1.65 million barrels a day, analysts from energy consultancies FGE and Wood Mackenzie said.
This is the slowest annual growth for diesel since 2014, down from a rise of more than 5 percent in 2015 and 2016.
"The slowdown is a result of the demonetization drive, which dampened economic growth for a few months since its implementation in November last year," said Sri Paravaikkarasu, head of FGE's East of Suez Oil.
Prime Minister Narendra Modi in November declared notes of 500 rupees and 1,000 rupees illegal tender, taking about 86 percent of total currency out of circulation, in a move that hit sales of cars and motorcycles and small businesses.
April sales of India's commercial vehicles, which consume mainly diesel, fell 23 percent year-on-year, for instance. Sales of passenger cars and motorcycles, however, mostly powered by gasoline, have started to recover.
Woodmac expects India's diesel growth to moderate at 3.2 percent a year over 2017 to 2025, down from an average annual growth rate of 3.9 percent from 2010 to 2016.
"The main reasons for a slowdown lies in increasing fuel efficiency, more substitution (for) oil, primarily diesel, in the power sector and a bearish outlook for diesel cars in India," said Sushant Gupta, research director for Woodmac's Asia-Pacific refining.
Still India's diesel demand growth in 2017 accounts for one third of Asia's demand growth for the fuel, he said.
"It is a positive story compared with China, where we expect diesel demand to be in slow decline in 2017." (Reporting by Jessica Jaganathan; Editing by Tom Hogue)