"India's large deficits and public debt are exacting an economic cost in terms of foregone growth," the International Monetary Fund said in an annual review of India's economy, Asia's third largest.

The fund also said it was concerned that growth was still off mid-1990 levels of 6.5 per cent which had implications for reducing poverty in the world's second-most populous nation.

India's fiscal deficit was 5.9 per cent last year, exceeding the initial target of 5.3 per cent. In 2003/04 (April-March) the government aims to keep it at 5.6 per cent.

The fund said the country's 2003-04 budget "makes little headway" in checking the fiscal imbalances.

"The large fiscal imbalances leave little room for maneuver in the face of shocks and have tended to result in ad hoc policy changes, which increase investment uncertainty," the fund said in a statement.

It said India's inflation was expected to moderate to around 4.5 per cent by the end of the 2003-04 fiscal period, with the external current account seen remaining in surplus.

Good monsoon rains were forecast, the fund said, and there was potential for an even stronger rebound in India's key agricultural sector which brightened growth prospects.

India should use the current favourable external and interest rate environment to build political consensus to accelerate fiscal and structural adjustments, the IMF said.

It said India needed a clearer strategy on the future role of development finance institutions, given their overall weak financial condition.

"Owing to the current fiscal situation and need to contain systemic risk, they encouraged the authorities to move away from government-orchestrated rescue packages of these institutions, with little conditionality," it said.

The IMF praised authorities for financial sector reforms but said it needed to broaden the scope of the market for interest rate derivatives and tighten the regulatory treatment of state-government guaranteed loans.

It also called for early action on lifting restrictions on agricultural marketing and trade and reforming the public distribution system, minimum support prices and fertiliser subsidies.