India's economy grew at its slowest pace in five quarters during the March quarter, as rising interest rates crimped consumption and investment, although the central bank is expected to continue tightening rates in its battle against inflation.

Annual gross domestic product grew 7.8 percent in the March quarter, lower than the 8.3 percent expansion in the previous quarter and below the median forecast for growth of 8.2 percent in a Reuters poll.

For the full fiscal year 2010/11, the economy grew 8.5 percent compared with the government's forecast of 8.6 percent.

Not a disaster but adds to the idea that EM (emerging market) growth is cooling as tighter policy kicks in, said Jonathan Cavenagh, senior FX strategist in institutional FX sales for Asia at Westpac Institutional Bank in Singapore.

With inflation still elevated and more work to be done by the RBI, tighter policy still seems likely, which will not be welcome by the equity market, he said.

Most economists expect the central bank to raise its main policy interest rate by 25 basis points at its review on June 16, after it raised its key rates by a bigger-than-expected 50 basis points early this month.

India's 10-year benchmark bond yield fell 2 basis points to 8.37 percent immediately after the data, which was seen to ease pressure on the central bank to tighten rates aggressively.

The 30-share BSE index <.BSESN> pared gains to be up 0.7 percent at 18,369.92 points. It was up about 1 percent before the data was released.

From the policy perspective clearly this could be some surprise, but it's not enough to change expectations. Would still think that 25 basis points should be on, said Nomura economist Sonal Verma, referring to an expected June rate increase.

The farm sector expanded at 7.5 percent during the quarter from the previous year, while manufacturing grew 5.5 percent, lower than 6.0 percent annual growth a quarter ago.

Agriculture is expected to perform well for the second straight year after the government forecast a normal monsoon in 2011. Prospects for the summer harvest got a boost after annual monsoon rains hit the southern state of Kerala two days ahead of schedule.

Still, rising borrowing costs and higher input prices have started to crimp consumer demand.

The Reserve Bank of India has raised its policy rate by a total of 250 basis points in nine moves since March 2010 as part of battle against stubbornly high inflation. Analysts have expected a further 75 basis points of increases by the end of December.

April car sales rose at their slowest pace in nearly two years, rising 13.2 percent from a year earlier, as higher interest rates, fuel prices and vehicle costs crimped demand in the world's second-fastest growing auto market.

Construction of big projects was delayed during the winter over environmental clearances as well as difficulty securing coal for new power plants.

(Reporting by Rajesh Kumar Singh; Editing by Tony Munroe)

India Inflation