By Chris Thomas

BENGALURU (Reuters) - Moody's Investors Service cut India's ratings outlook to "negative" from "stable", citing increasing risks that Asia's third largest economy will grow at a slower pace than in the past, sending stock markets nearly 1% lower at Friday's close.

The cut in outlook partly reflected government and policy ineffectiveness in addressing economic weakness, which has led to an increase in debt burden, Moody's said. (http://bit.ly/2NopI10)

The ratings agency also cut its outlook for 21 Indian companies, including State Bank of India <SBI.NS>, Indian Oil Corporation Ltd <IOC.NS>, Infosys Ltd <INFY.NS> and NTPC Ltd <NTPC.NS> to "negative" from "stable".

However, Moody's retained the country's foreign and local currency ratings at 'Baa2'.

India's economy grew 5% year-on-year between April and June, its weakest pace since 2013, which had prompted a slew of interest rate cuts by the central bank and forcing the government to cut corporate taxes sharply.

Moody's now expects a government deficit of 3.7% of GDP in the fiscal year ending in March 2020, compared with a government target of 3.3%.

"The depth and duration of India's growth slowdown, prolonged financial stress among rural households, weak job creation, and, more recently, a credit crunch among non-bank financial institutions have increased the probability of a more entrenched slowdown," Moody's said.

The ratings agency said it does not expect the credit crunch among non-bank financial institutions to be resolved quickly.

In response, the finance ministry said the economy's fundamentals remained "quite robust".

"India continues to be among the fastest growing major economies in the world, India's relative standing remains unaffected," the ministry said in a statement.

However, Indian bourses inched lower, with the broader Nifty 50 index <.NSEI> closing down 0.86%. The rupee <INR=D4> weakened to 71.25 against the dollar by 1019 GMT, versus Thursday's close of 70.965. [.BO]

Overall weak demand in the economy continued to weigh on corporate growth. Government data earlier this week showed the pace of fuel demand were set to fall to its lowest in at least six years.

The domestic auto sector is also in the middle of one of its worst slowdowns ever, while overall jobless rates rose to 8.5% in October, the highest since August 2016.

(Reporting by Manojna Maddipatla and Chris Thomas in Bengaluru; Editing by Subhranshu Sahu and Arun Koyyur)