See 25 bps hike in repo, reverse repo rate on Sept 16: RBS

Excerpts from Markets Midday on CNBC-TV18 Watch the full show » RELATED NEWS GDP grows most since Dec 2007; tightening seen RBI report: What are key challenges India is facing? RBI report gung-ho on growth, worried about inflation RBI official: liquidity situation has improved

The Reserve Bank of India (RBI) has their next policy review taking place on September 16. Gaurav Kapoor, Senior Economist at Royal Bank of Scotland (RBS) is of the view that the RBI will increase key rates by 25 basis points (bps). On the back of robust growth he said, "I think they would go ahead with another 25 bps hike in both policy rates. I think that will be followed by another round of policy rate hikes in October as well."

Manufacturing, services and the farming sector seem to have great momentum. He appears positive on India achieving 8.5% growth. He however feels that the India growth story could be hit, with consumption being affected by increasing inflationary pressures. "While they do indicate that consumption is good and strong, I don't think it gives a true macro picture. This data clearly points out that consumption is getting affected by inflation and especially in essential commodities," he said.

Below is a verbatim transcript of his interview on CNBC-TV18, with Latha Venkatesh. Also watch the accompanying video.

Q: The capital formation from 3.7% which was the old number, now we have 7% growth but it is still about 20% lower than the quarter ago number. Does this new set of numbers improve your image of the Indian growth story?

A: By and large it ties in with the fact that the previous quarter clearly saw a fairly sharp pickup in investment activity. This quarter things have stabilized, this is what the data is pointing out. If you compare it with the first quarter of last year, clearly things have significantly improved, especially on the investment side.

If you were to compare the contribution of investments to growth, it is significantly better this quarter of this year compared to the same quarter last year. Of course same quarter last year the situation was drastically different.

Q: Looking at these numbers, like you said, they still show that they have peaked off and investment activity appears to have stabilized, if you have to believe these numbers are right. Then are you changing your outlook on how the next three-four quarters will pan out?

A: Not necessarily. We were expecting the GDP growth to peak in this particular quarter. Even from a sectoral perspective, if you see, the manufacturing sector growth has come down into single digits and I think that is likely to persist.

What is driving the momentum from a sectoral perspective is the services sector which has started to take off only in the last couple of quarters. Particularly the last quarter is when you see services sector showing great attraction and with farm economy looking to do much better than last year. From a sectoral perspective, we are pretty much on track to achieve 8.5% growth.

From the expenditure side, I think the investment side of the story, there is some amount of correction or some amount of slowdown so to say was to be expected, with inflation being high and interest rates picking up. By and large you would see some stabilization in activity as we go ahead.

Q: On personal consumption expenditure, even after the revision is just about 3.8% higher. Doesn't quite tie-in with the fact that our auto sales numbers, two-wheeler numbers, consumer durable numbers are all going gung-ho. Is there still disbelief with these numbers and how will you read them in terms of growth?

A: The auto sales or the other numbers are purely anecdotal in the overall consumption basket. If you look at it, perhaps their proportions even now is fairly small. While they do indicate that consumption is good and strong, I don't think it gives a true macro picture. This data clearly points out that consumption is getting affected by inflation and especially in essential commodities. This is something which we have seen even in the past. This is where the spot of bother is from the expenditure side.

Q: Since you said it is probably inflation that is putting a break on consumption, what is the reading for September 16 from the Reserve Bank of India?

A: I think they would go ahead with another 25 bps hike in both policy rates. I think that will be followed by another round of policy rate hikes in October as well. From the RBI's perspective, a slower growth in demand is something which would tend to mute the kind of response they would want to go ahead and do. At this point in time they are still in the process of normalization of monetary policy.

Once that is done which is perhaps another 50-75 bps away, then is the time they would have to decide whether they want to go in for more rate hikes and take a more aggressive stance because clearly un-tackled high levels of inflation would affect growth going forward.