Mumbai: India's economy is likely to grow 8.5 per cent in the fiscal year 2008-09 beginning April 2008, provided the government moderates taxes to spur demand for consumer durables, C Rangarajan, former governor of the Reserve Bank and chief of the prime minister's economic panel, has said.

The prime minister's economc advisory committee (EAC), which is headed by Rangarajan, wanted finance minister P Chidambaram to make some adjustments in the income tax slabs in order to boost consumer demand.

To stem the recent slowdown in the growth of the manufacturing sector, the panel has suggested some adjustments in indirect taxes to stimulate growth in consumer durables.

While the economy is widely expected to grow at 8.5 per cent in the next fiscal (2008-09), there are fears of a slowdown in view of the high interest rates and a slowdown in the manufacturing sector.

Consumer durables output growth fell to 4.1 per cent in November, compared with 10.1 per cent in the same month a year earlier following a spate of interest rate hikes.

India's economy grew 9.4 per cent in fiscal 2006-07, its strongest in 18 years. But annual growth dipped to 8.9 per cent in the September quarter, falling below 9 per cent for the first time in three quarters of the current fiscal, as industrial output slowed amidst monetary tightening measures to contain inflation.

"We discussed the likely trends for the economy. It will grow around 8.5 per cent in the next year but there are some pressure points, like the manufacturing sector," Rangarajan told reporters after meeting the finance minister.

The Rangarajan panel has also suggested the finance minister to increase public expenditure.

The finance minister had last month fuelled expectations of a tax cut after he said that there could be a case for moderation of rates if voluntary tax compliance increased. (See: Finance ministry hints at moderate income tax rates)

He made the remarks after reports that direct tax collections witnessed over 40 per cent growth this fiscal and looked all set to cross the Rs3,00,000-crore mark.

This may imply a higher exemption limit for personal income tax, while the rates remain the same.

Top economists in the country have, however, cautioned the government against any reduction in direct taxes at this stage. They say instead of slashing personal tax rates, the government should try and rationalise the excise duty structure and take care of the mounting subsidies.

Economists have also pointed out that apart from the salary burden arising from the Pay Commission report, the government would be under a lot of fiscal stress in the next fiscal due to the upcoming oil bonds and market stabilisation scheme bonds.