* Oil product demand growth to fall up to 40 pct from 2016
* Slowdown in factory activity to curb diesel demand
* Cash crunch cuts into car sales, gasoline demand
India's fuel demand growth is expected to slow by as much as 40 percent in 2017 from last year as a government-induced cash shortage hurts businesses, industry and car sales.
The dent in demand growth in the world's third-largest oil consumer is expected to be temporary, though, with India still taking up the third-biggest portion - behind China and United States - of 2017's rise in fuel use on a barrel-per-day basis, according to energy consultancy Wood Mackenzie.
India's fuel demand in 2016 grew at its fastest in at least 16 years as low oil prices boosted demand for gasoline and aviation fuels, but analysts say the nation's currency troubles will put the brakes on this year.
India's oil product demand growth in 2017 is expected to drop to 160,000 barrels per day (bpd), from 270,000 bpd in 2016, according to Woodmac.
"We see Indian demand growth slowing ... due to the recent currency demonetization drive by the Indian government," said Suresh Sivanandam, the consultancy's Singapore-based senior manager of Asia Pacific refining research.
Prime Minister Narendra Modi's currency crackdown has led to a cash crunch that has severely hurt India's overall output and consumer demand, with December factory activity contracting in its biggest monthly decline in eight years and last month's car sales dropping the most in 16 years.
India's growth in both diesel consumption - used mainly for heavy industrial vehicles - and gasoline burned to power cars, is expected to slow, especially in the first quarter, traders and analysts told Reuters.
And while this will dent refining margins for diesel, it is not expected to be enough to undercut a strong 2017 profit outlook for the fuel across Asia this year.
"The cash crunch ... is dampening growth in agricultural and other small-to-medium scale sectors, which are heavily cash-reliant," said Sri Paravaikkarasu, head of East of Suez Oil at energy consultants FGE.
"It will easily take three to six months for the dust to settle," she said, although long-term prospects remain strong, with spending on infrastructure projects and a resumption in economic growth and freight shipments supporting diesel.
Diesel demand is expected to grow only 2 percent in the first quarter of 2017 compared with a year ago, less than half of the 5 percent growth rate seen in the first 10 months of 2016, said Tushar Tarun Bansal, director of Singapore-based consultancy Ivy Global.
Actual oil demand growth may be lower than projected, though, cautioned an Indian refiner source, as consumers have been stocking fuel to take advantage of an exception given to old 500 and 1,000-rupee notes for purchases of diesel and gasoline at retail pumps.
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