Mumbai: Indian economy is likely to grow by 8.5 per cent in FY'12 on the back of services sector and industry expansion, Prime Minister's Economic Advisory Council (PMEAC) Chairman C Rangarajan said on Thursday.

"It is my estimate that the Indian economy will grow at 8.5 per cent in 2011-12. The growth from agriculture may not be so high, but services and industry compensate for that," Rangarajan said at the 26th Skoch Summit in Mumbai.

However, he added, "It is prudent to aim at a growth rate between 9 per cent and 9.5 per cent. Pushing the economy beyond that will run into problems."

In its monetary policy for 2011-12 released earlier, the RBI projected the economy to grow by 8 per cent this fiscal, lower than the government's original forecast of 9 per cent.

On inflation, Rangarajan said, "In the early decades of independence, the argument was that inflation was endemic in economic growth and led to very steep increases in prices. We
should not let that happen in the years of high growth... (We must) re-anchor the inflationary expectations to the 4-5 per cent comfort zone."

He also cited rising inflation as a "disturbing element".

On food inflation, he said, "The last few months have shown a declining trend in vegetable prices and it is expected that inflation will come down in the coming months, even though it may remain at a high level for some time."

Food inflation shot up to 8.55 per cent for the week ended May 14, the highest level in four weeks, as prices of fruits, cereals and protein-based items escalated.

However, he was hopeful of seeing overall inflation coming down to 6 per cent to 6.5 per cent by March, 2012.

For the month ended April, overall inflation came down marginally to 8.66 per cent on the back of moderation in prices of certain food items, in line with the government's expectations.

"The farm economy and the power sector are the two sectors which pose a major challenge in the medium term," Rangarajan added.

He also stressed upon the need to reduce the current account deficit to 2.5 per cent of the Gross Domestic Product (GDP) of the country, saying, "Over a longer period of time,
we need to keep the current account deficit at 2.5 per cent of the GDP. We should strive to maintain the fiscal deficit at 4.6 per cent even if it entails cutting subsidy."

The country's current account deficit stands at around 3 per cent. The fiscal deficit has been projected at 4.6 per cent of the GDP in the 2011-2012 Budget.

On the environment versus growth debate, Rangarajan said, "At our present stage of development, we can not afford to sacrifice growth. Growth is an important factor in generating employment and reducing poverty. It is key to improving the living standards of our people."