Okay. I got it running. I had to do the following change to make drush dl work on windows 7. Apparently "which wget" wasnt returning anything as windows doesn't have a 'which' command. I hacked the drush core to do the following changes.
- Go to file drush.inc in folder C:\ProgramData\Drush\includes
- Change the line $use_wget = drush_shell_exec('which wget'); with $use_wget = drush_shell_exec('where wget');
Root Cause:Windows doesn’t have 'which' command, 'where' command serves the purpose
I think there was no issue with proxy at all and it was using proxy from drupal's settings.php file correctly