UPDATE 3-India's economy slows to weakest pace in more than 2 yrs
* Growth lowest in more than two years, and broad-based
* Little room seen for short term fiscal fix for economy
* Pause in rate rises, possibly some form of easing likely
NEW DELHI, Nov 30 (Reuters) - India's economy grew at its weakest pace in more than two years in the quarter that ended in September, revealing the heavy toll that stubborn inflation, rising interest rates and crisis-hit global capital markets are having on Asia's third-biggest economy.
Gross domestic product growth fell to 6.9 percent in the second quarter of the financial year, slipping below 8 percent for the third straight quarter.
Weakness in the second quarter was broad-based. Manufacturing, accounting for 16 percent of GDP, grew at only 2.7 percent and mining contracted 2.9 percent.
Economists suspected the pace of economic growth may languish at seven percent in the coming quarters, and that even if the central bank isn't willing to cut interest rates, it might feel compelled to ease monetary conditions by other means.
The economy has been hit by a confluence of factors. Inflation has been persistently high all year, policy inertia has hurt investment and industrial output and, now, capital outflows have pushed the rupee to new lows.
While investors have called for economic reforms - such as making land acquisition for industry easier and opening up the retail market to foreign firms - there appear few short-term fixes.
Montek Singh Ahluwalia , deputy head of the planning commission and one of Prime Minister Manmohan Singh's closest advisors, said a stimulus was unlikely, adding that growth in the next quarters may improve.
"We hope these problems will be overcome in the second half of the year. Plus we hope that investment implementation hurdles will get overcome and that should give a boost to investment especially in the infrastructure sector."
There is little fiscal room for the government, which has already announced extra spending of around $11 billion and is struggling to meet its fiscal deficit target.
"It will be tough for the government to provide any fiscal stimulus to revive growth as their finances are already strained and they need to ensure the fiscal deficit doesn't get out of control," said D.K. Joshi, chief economist at Crisil in Mumbai.
"So they will have to do some tough balancing act."
Finance Minister Pranab Mukherjee said the global economic situation was depressing growth, and forecast GDP growth for full-year ending in March 2012 dropping to 7.3 percent from an initial prediction of around 9 percent.
The headline GDP figure was in line with the median forecast in a Reuters poll for an annual rise of 6.9 percent, and compares with 7.7 percent growth in the previous quarter.
India's benchmark 10-year federal bond yield eased briefly to 8.75 percent at 0525 GMT, down 8 basis points on the day, while stocks reversed early losses and were up 0.2 percent.
The slowing economy will also add to pressure on the ruling Congress party-led coalition, hit by corruption scandals and policy limbo ahead of crucial state polls next year that will pave the way for a 2014 general election.
Thirteen interest rate increases have failed to arrest inflation, which is close to a double-digit rate, and high food prices have proved one of the biggest issues for voters.
The Reserve Bank of India (RBI) has indicated the low possibility of another rate increase, and some economists said Wednesday's data would add to the pressure to hold back on any tightening.
"The GDP data increases chances of monetary easing as it is a sharp drop and the weakest growth since 2009," said Dariusz Kowalczyk, senior economist and strategist at Credit Agricole in Hong Kong.
Some analysts said that while rates may not be cut, there could be some measures to raise liquidity and help private investment. The RBI could for instance reduce the proportion of their deposits banks have to place at the central bank.
"There is significant weakness in the economy, and that is what needs to be factored in," said Saugata Bhattacharya, economist at Axis Bank in Mumbai.
"There will probably be some easing action, I don't know if it will be a rate cut. I think it will come firstly in liquidity, and then a rate cut."
The Indian economy grew at 8.5 percent in 2010/11. GDP growth has been below 8 percent for the past three quarters. Indian corporates, particularly in the auto and real estate sector, have been hit by rising input costs and a slowdown in demand.
Farm output has gradually declined. It rose an annual 3.2 percent in the July-September quarter, down from the previous quarter's 3.9 percent growth .
Growth has been slowing across Asia owing to the slump in demand from stalling developed economies. China's economy slowed down to 9.1 percent in the third quarter, from 9.5 percent in the second quarter, while the OECD cut its forecasts for the global economy to 3.4 percent for 2012.
The global economic recovery is running out of steam, leaving the euro zone stuck in a mild recession and the United States at risk of following suit, the OECD said on Monday, sharply cutting its forecasts.