The government warned on Friday that a slowdown in foreign direct investment inflows as well as tepid growth in developed countries could hit the country's exports and strain its balance of payments.
The finance ministry's annual economic survey said a persistent anti-inflationary monetary stance was needed given high inflation - pushed up by global commodity prices -- and growth. The ministry also said farm output must be increased to combat high food prices.
"Inflation is clearly the dominant concern," the report said, adding that the government needed policies to help reverse a fall in FDI inflows to $19 billion in the fiscal year to November 2010. FDI totaled $33.1 billion in the 2009/2010 fiscal year.
The survey, a precursor to Monday's budget, said reforms were needed to streamline both land acquisition for industry and environmental clearances for infrastructure projects to sustain India's growth momentum.
Already hit by a slew of corruption scandals, the Congress-led government faces a battle to contain stubbornly high inflation, pushed up by food prices, without hurting economic growth amid signs a possible slowdown in industrial production.
Rising oil prices spurred by unrest in Libya are also worrying policy makers. India faces the dilemma of either passing on oil price rises to consumers and risking voter anger, or absorbing price rises in subsidies that may strain goverment finances.
"The survey shows that while economy has entered into a super-cycle of benign growth trajectory of 8-10 percent, there are also headwinds like inflation, current account deficit, fiscal deficit, stagnation in agriculture and industry output and quality of capital inflows," said Brinda Jagirdar, general manager and head of economic research at State Bank of India.
The economy grew 8 percent in the fiscal year 2009-10 and growth momentum accelerated through the first half of the current fiscal year through September to nearly 9 percent as the farm sector rebounded after it was hit by drought the previous year.
Prime Minister Manmohan Singh had said earlier this month that high inflation is a risk to growth momentum. His government is committed to achieving a high growth rate of 9 to 10 percent.
Policymakers have expressed worry about India's current account deficit, which widened in the September quarter to a record high of $15.8 billion, as booming consumer demand sucked in imports and service sector exports suffered from tepid global demand.
A recent report by Goldman Sachs said India's current account deficit may widen to a record 4 percent in the current fiscal year ending March from 2.9 percent in the previous year.
The report also said the current account gap could grow to 4.3 percent in the fiscal year that ends in March 2012, and warned that increasingly the huge gap is being financed by short term flows.
A trade ministry document released on Wednesday said that a high trade deficit could lead to an unsustainable current account deficit and may also trigger balance of payments difficulties.