(Recasts with analyst comment, background, byline)
By Surojit Gupta
NEW DELHI, Dec 4 (Reuters) - Indian authorities are expected to cut interest rates soon and take steps to galvanise economic activity after last week's bloody attacks which dealt a further blow to an economy already decelerating in the global slowdown.
A senior government official said the Reserve Bank of India would reduce two key interest rates to provide stimulus to the financial industry, following action in October and November to keep funds flowing as the global credit crisis paralysed lending.
India long hoped it would avoid the worst of the slowdown which has dragged big economies into recession, but even before last week's rampage by Islamist gunmen through the financial hub, Mumbai, there were signs of waning growth.
Economists said further steps needed to be taken to sustain annual economic expansion at a rate that would ensure job creation kept pace with India's young and fast-growing workforce.
"With investment spending declining rapidly...it becomes imperative for a stimulus package if the economy has to grow at a certain growth rate, whether it is 6-7 percent, to create jobs," said Sujan Hajra, economist at Anand Rathi Securities.
The 10-year government bond yield first dipped to its lowest since April 2005 on Thursday as expectations of lower rates gathered force, then rose to 6.80 percent, 2 basis points above Wednesday's close, on concerns of more borrowing.
The central bank has slashed its key lending rate, the repo rate, by 150 basis points to 7.5 percent since Oct. 20 and taken the proportion of deposits banks must keep in reserve down 350 basis points to 5.5 percent.
The 30-share index initially seesawed on Thursday, with investor confidence fragile after last week's attacks and siege of a Jewish centre and two luxury hotels in the heart of the business district, in which 171 people were killed.
The index has shed 57 percent so far this year, taking the rupee, whose fortunes are heavily tied to foreign capital flows, to a record low of 50.65 per dollar on Tuesday.
The partially convertible currency was at 49.76/7850 on Thursday, aided by expectations of a stimulus package.
AUTOS
The government official, who declined to be identified, said policies would include steps to improve infrastructure and help the car industry, which has seen sales tumble in recent months.
Prime Minister Manmohan Singh held a meeting on Tuesday to chart economic action and the official, who attended the meeting, said excise duty cuts were planned for the car industry.
"On the financing side, the Reserve Bank of India will announce the measures," he said. "They would include a range of measures such as reduction in repo and reverse repo rates."
According to a statement issued late on Tuesday by the office of the prime minister, who has temporarily taken over the finance portfolio, policies would be announced by the end of the week.
The reverse repo rate, at which the central bank absorbs cash from the market, has held at 6.0 percent since July 2006.
India's economy showed its slowest pace of growth in nearly four years in the September quarter, easing to an annual 7.6 percent from 7.9 percent in the quarter before.
The central bank forecasts growth of 7.5 to 8.0 percent for the fiscal year which ends on March 31 but private sector economists say it is more likely to be closer to 7 percent.
After the credit crisis froze India's lending markets in October, firms have struggled to raise capital.
A survey this week showed manufacturing activity contracted sharply in November, while exports fell an annual 12.1 percent in October, the first year-on-year fall in nearly three years.
Several banks are now predicting growth will drop below 6 percent in the 2009/10 fiscal year, a rate outlined to Reuters last week by India's chief statistician as the watershed below which unemployment would climb.
But economists warn the public purse is already strained with a farm loan waiver, subsidies and a hike in civil servant pay, so the government had little room to spend like neighbouring China, which last month announced a $586 billion emergency package.
"The deficit will have to be put on the backburner if significant fiscal push has to be given," said D.K. Joshi, principal economist at domestic credit rating agency Crisil. (Editing by Charlotte Cooper & Jan Dahinten)