India will focus on driving domestic demand until key developed economies recover and will not exit fiscal stimulus measures until necessary, Finance Minister Pranab Mukherjee said on Tuesday.

Separately, Reserve Bank of India (RBI) deputy governor said India faces a dilemma of needing to contain rising inflation while trying to support growth and managing foreign capital inflows.

"There is a need of generating strong domestic demand until the robust recovery all over the world, particularly the developed world, takes place," Mukherjee told a World Economic Forum event in New Delhi.

To tap domestic demand, which has helped insulate India from the worst of the downturn, Renault, Nissan Motor Co and their Indian partner on Tuesday announced plans to make an ultra low-cost car for India's emerging middle class.

Globally, companies and investors are looking to China and India as growth drivers to offset the downturn in established markets.

"The train is leaving the station now. You have to ensure that capacities are coming because India will be taking off, already taken off in terms of the car market," Carlos Ghosn, CEO of Renault and Nissan told a media briefing at a World Economic Forum event on Tuesday.

He was one of several corporate officials expressing bullishness about domestic demand in Asia's third largest economy during the three-day event.

That sentiment was boosted by Prime Minister Manmohan Singh's announcement on Sunday that financial reforms, such as building up a domestic bond market and expanding foreign investment in sectors like insurance, would be pushed forward.

Mukherjee repeated his pledge for massive investments in the agriculture sector and infrastructure, and acknowledged that it would be a challenge for India to compensate for the loss in exports through domestic demand.

"It is not easy for us to diversify the market overnight and make up the loss, so we shall have to wait for some time," he said.

Still, India is one of the few countries in a position to talk about withdrawing extraordinary measures implemented to help it weather the global downturn, and is expected to be among the first of the Group of 20 nations to begin raising interest rates to curb looming inflation.

Inflationary pressures in India were higher than those in developed countries, but tightening policy too early could weaken recovery and attract more capital inflows which would complicate policymaking further, RBI Deputy Governor Shyamala Gopinath said.

"India is actively confronted by an upturn in inflation," she said in a speech at a banking event in Mumbai, adding the timing of the withdrawal of supportive monetary policy might diverge considerably between developed and emerging nations.

Some economists have said inflation could reach 8 percent by the end of the fiscal year in March, well above what is perceived to the central bank's comfort level of about 5%.

"Capital flows have resumed on India's growth prospects," Gopinath said, saying the costs and benefits needed to be considered in managing the impact of foreign fund flows.

"On that backdrop, we really need to consider the exit from expansionary policy because we cannot be an outlier here."

India's benchmark stock index is up 70 percent this year, boosted by net foreign funds inflow of more than USD 14 billion.

Growth path

The finance minister said he was hopeful of economic growth of more than 7% in the fiscal year ending March, 2011.

"Maybe in 2012 we will be able to reach the magic figure (of 9-10% growth)," he said.

Policymakers including the prime minister have pressed the case for keeping easy fiscal and monetary policies in place to nurture growth.

"This cannot continue for a long period of time," Mukherjee said, referring to the exit from easy fiscal policy.

"I have stated a number of times that in due course we shall have to take the corrective measures."

India's economic growth slowed to 6.7% in the fiscal year through March after three straight years of at least 9%, and government officials have said growth in the current year is on track for roughly 6.5%.