UPDATE 2-India deficit to widen on spending; markets fall

* Fiscal deficit to expand to 6.8 pct of GDP this year

* Bond yields rise, stocks fall 5 pct

* To accelerate infrastructure development

* To step up support for farmers

* Calls for return to fiscal responsibility targets (Adds details, quotes, updates markets moves)

By Surojit Gupta and Tony Munroe

NEW DELHI, July 6 (Reuters) - India said its fiscal deficit would widen as it outlined increased spending on infrastructure, farmers and the poor in the first budget since Prime Minister Manmohan Singh's government was reelected by a resounding margin. Stocks tumbled 5 percent and bond yields rose after Finance Minister Pranab Mukherjee, sticking to the theme of "inclusive growth" espoused by the ruling Congress party, said the fiscal deficit for the year that ends in March 2010 would increase to 6.8 percent of GDP, from 6.2 percent in the previous year.

Investors had expected the fiscal deficit to increase to up to 6.5 percent, and were disappointed by an absence of sweeping reforms or pro-market measures.

"The real concern emerging from the budget is that it has not given confidence as to how the government will go about the fiscal consolidation process, after hiking the fiscal deficit target," said Rupa Rege Nitsure, chief economist at Bank of Baroda in Mumbai.

"While the thrust on agriculture, infrastructure, etc. augurs well from a long-term growth perspective, the fiscal profligacy is quite obvious in the near term," she said.

The first budget of Singh's new administration is seen as a roadmap for how he will govern for the next five years after his Congress party-led coalition was reelected by an unexpectedly decisive margin.

"The first challenge is to return the GDP growth rate of 9 percent per annum at the earliest," Mukherjee said in his address to parliament. "The second challenge is to deepen and broaden the agenda for inclusive development."

Mukherjee said overall spending would increase by 36 percent this year, but he also called for a return to fiscal responsibility targets "at the earliest."

He said states should remove bottlenecks for infrastructure projects, and outlined plans for more flexible financing for infrastructure and development of long-distance gas pipelines.

Inadequate power supplies and transport links have long been a bottleneck to India's growth.

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