GDP Growth 8.8%

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Morgan Stanley tweaks FY11 growth forecast up to 8.4% (from 8.1%) after 8.8% June growth surprised us a bit. This bears out our standing call about the economy returning to an 8% trajectory. Although we have no doubt whatsoever that domestic fundamentals are strong, we cannot but increasingly worry about the weakening of G-3 recovery. They have also raised have services sector growth forecast to 9.4% from 8.8% after trade and transportation grew higher-than anticipated 12.2% in June.

Expect the RBI to hike 25b on September 16 against this backdrop of strong growth and still-high inflation (9.5% August WPI inflation BofAMLe). At the same time, Gov Subbarao will likely pause 50-75bp later with inflation cooling off, industrial growth peaking off and G-3 recovery weakening.

While favorable farm output and the rural demand recovery support upside risks to our GDP growth forecasts for F2011, the external risks from exports, capital inflows and confidence channels, on balance leave it unchanged. Morgan maintains F2011 GDP growth estimate of 8.5%.

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HSBC in a report said,

Growth hit the mark - a two and a half year high. All expected, but the details still contained surprises. Industry grew, and so did agriculture, but the real kicker came from services. This reflects a much needed pick-up in investment as capacity is exceedingly creaky and crunched. But, private consumption is yet to take off, and we still count on this to happen. So growth looks robust. Good for those running businesses, tricky for those running monetary policy. The
latter can hardly afford to relax: yes, headline WPI will come down, but underlying inflation is still too strong for comfort. Rates? Higher.

High inflation continues to pose a risk to growth, but supply side drivers to inflation have eased more recently and are likely to pull down y-o-y WPI inflation from double digit rates currently. However, with the economy firing above potential, demand pull inflation risks have increased significantly. Having said that, WPI inflation could decline to low single digit by year end purely due to base effects and improved supply from better monsoons this year.

External demand could be a worry, while a stronger domestic economy and one that is growing above trend is likely to suck in imports thereby worsening the trade balance. We dont see the Reserve Bank of India (RBI) pausing at its 16 September meeting: expect policy rates to be tightened by a further 25bps with emphasis on accelerating the transmission of policy rate hikes already delivered. Increasingly, monetary policy will be aimed not only at  maintaining price stability but also at tempering domestic demand with a view to maintaining external (read: current account) balance.