* India Sept quarter GDP up 7.9 pct y/y vs 6.3 pct forecast
* Growth fastest in 18 months on manufacturing, stimulus
* Farm output tops forecasts but set to slow in Dec quarter
* Faster growth, inflation adds to debate on stimulus exit (Recasts, adds CPI, reaction, details)
By Manoj Kumar and Rajesh Kumar Singh
NEW DELHI, Nov 30 (Reuters) - India's economy grew at its fastest rate in 18 months in the quarter through September, smashing expectations and adding pressure to bring forward a rate rise and cut stimulus spending as inflation mounts.
Asia's third-largest economy grew 7.9 percent in the past quarter from a year earlier, far above forecasts of 6.3 percent, but growth was expected to slow this quarter when the impact of a weak monsoon would be seen on crops, giving the government room to keep pro-growth policies in place for the near term.
India's expansion was driven by government spending, manufacturing, services, and better-than-forecast farming output, sending bond yields and swap rates higher as investors bet on a rise in rates and the finance minister said growth could hit 7 percent in the fiscal year ending in March 2010.
"This data could be a green light for the Reserve Bank of India to hike rates, and there are greater chances of this by end of the calendar year," said Robert Prior-Wandesforde, senior Asia economist at HSBC in Singapore.
"The exit from the fiscal stimulus by the government may also be earlier post the GDP data," he said.
Prior to the data, most economists had predicted a rate rise sometime between January and April 2010.
A top government official played down inflation concerns.
"I don't believe there are serious worries on inflation except food prices. Food prices are a matter of concern, but I don't think conventional monetary policy will take care of that problem," said Montek Singh Ahluwalia, deputy chairman of India's powerful Planning Commission.
He reiterated the government stance that stimulus would remain in place. "Personally, I don't think the second quarter numbers suggest any change in the (fiscal) policy in the current year."
Manufacturing output grew 9.2 percent in the quarter as consumers bought more cars and other goods.
Larger neighbour China, which along with India is helping to pull the global economy out of its worst recession in decades, clocked growth of 8.9 percent during the same quarter.
The yield on the 10-year benchmark bond
INFLATION, FARMING IN FOCUS
India's annual wholesale price inflation was a benign 1.34 percent in October, but economists have said it could rise to as much as 8 percent by the end of the fiscal year -- above the central bank's perceived comfort zone around 5 percent.
The consumer price index, which is not watched as closely because it covers a narrower range of prices, rose 11.49 percent in October from a year earlier, slightly lower than September's annual rise of 11.64 percent, government data on Monday showed.
Food prices jumped 15.6 percent in the year to mid-November, although supply-side inflation is largely beyond the purview of monetary policy.
High food prices are sensitive in a country that remains mostly rural and poor, complicating government efforts to implement pro-market financial sector reforms.
On Monday, opposition party workers burned buses and shut down businesses in the eastern city of Kolkata to enforce a 12-hour strike to protest about rising food prices.
Agriculture, which accounts for roughly 17 percent of India's economy but employs half the country's workforce, remains a wild card after farm output grew 0.9 percent during the quarter, beating expectations for a decline.
Central bank Deputy Governor Subir Gokarn said he would not be surprised if economic growth slowed in the December quarter.
"While it is a recovery and it seems to be gaining strength, we should not ignore the fact that it is still being driven substantially by public spending," he told reporters.
Rajeev Malik, economist at Macquarie in Singapore, stuck with his view the bank would use liquidity management rather than rate rises in December and January as farming output was likely to fall.
On the plus side, long-running declines in exports and credit growth are poised to reverse in coming months as the global economy shows signs of recovery.
The central bank cut its key lending rate by 425 basis points between October 2008 and April. Late last month it began scaling back its monetary stimulus by removing some of the liquidity support measures implemented to help India weather the downturn.
The central bank will hold monetary policy review meetings in January and April, but can adjust rates at any time. (Writing by Tony Munroe; Editing by John Mair and Tomasz Janowski) ((rajkumar.ray@thomsonreuters.com; +91-11-4178-1006; Reuters Messaging: rajkumar.ray.reuters.com@reuters.net)) ((If you have a query or comment on this story, send an email to news.feedback.asia@thomsonreuters.com))