The budget deficit has limited the government's social investment

Higher interest rates, agricultural subsidies and pension payments in recent years had driven up the deficit to unsustainable levels, limiting investment in infrastructure and social sectors.

"The economy has slowed down quite substantially," Mahesh Vyas from the Centre for Monitoring the Indian Economy told the BBC's World Business Report.

"The substantial slowdown in the agricultural sector, and a resulting slowdown in domestic consumption, has had an impact on investment, bringing down the growth rate and affected employment opportunities as well," he said.

The annual Economic Survey, prepared by the finance ministry, is seen as a preview to the federal budget which Finance Minister Yashwant Sinha is due to present on Thursday.

Growth target missed

The fiscal deficit for the year ending in March is expected to shrink to 5.1% of gross domestic product, from 5.5% the previous year, as slower growth cut expected tax revenues.

The deficit target for the current year was for 4.7% of GDP.

The report said growth would be 5.4% in the year to March, up from 4% in the previous year but well short of the 8% the government says is needed to reduce poverty.

A turnaround in the recession-bound manufacturing sector has not occurred, but higher rural incomes from a bumper harvest are could push up demand for industrial goods and revive industry.

Political challenge

The survey highlighted the difficulties for the Bharatiya Janata Party (BJP), which heads the coalition government, to lift growth before elections in 2004.

On the weekend, the BJP was routed in state polls, losing control of Uttar Pradesh, its traditional power base, with many voters citing economic issues as their main concern.

The outcome could make it harder for the BJP to push through reforms, such as privatisation and relaxation of rigid labour laws.

The survey said the key disappointment of the 1990s economic liberalisation process was inadequate job creation, particularly in rural areas.