India?s GDP growth for the three months to June 2010 came in at 8.8% year-on-year, in line with consensus estimates and at a two-and-a-half-year high. The surprise factor: the big jump in growth in the services space at 9.7% y-o-y with almost every component chipping in and the sector heavyweight?trade, hotels, transport and communications?notching up a good 12%. Not that manufacturing is lagging behind; at 12.4%, the performance is equally impressive. As for agriculture the 2.8% posted in the June 2010 quarter should almost certainly be surpassed in the three months to September.

If economy watchers are a somewhat disappointed it?s because the demand side of the growth story isn?t playing out according to the script. For instance, personal consumption came in at Rs 6.6 lakh crore virtually flat compared with the number in the June 2009 quarter. In effect, private consumption was up just 0.3% y-o-y compared with 2.6% in the March 2010 quarter with the poor show being ascribed to high food prices that are eating into spends on other items. Also, as Standard Chartered points out, there?s been a fall in real consumption expenditure at a time when labour market conditions are improving, which is worrying. But if its food inflation that?s causing the problem, it should get sorted out once prices start to stabilise.

Again, the other engine of growth, capital formation, too doesn?t seem to have grown and at Rs 3.5 lakh crore was slightly above the number reported in the three months to June 2009. The growth in investments was a far more subdued 3.7% y-o-y compared with the stunning 17.7% seen in the March 2010 quarter. Although there may be a slowdown in the coming months, the growth momentum appears to be fairly good even if the growth in factory output moderated to just 7.1% in June and HSBC?s manufacturing PMI survey may have indicated a slight slowdown. Some of it could be attributed to the shortfall in capacity rather than any drop in demand and so GDP for 2010-11 should come in at 8% plus. If there?s a concern now it is that demand pull risks to inflation have increased significantly, though that too shouldn?t be too worrisome since wholesale inflation is expected to taper off by March next year thanks to a bumper harvest, which should cool food prices, and the base effect doing its bit.

Under the circumstances, it would seem that the central bank may not want to up key policy rates at its next meeting in mid-September though many believe that it may do so simply to send out the right signals. So, although the transmission of the hike in earlier policy rates is playing out as expected, and both lending and borrowing rates have increased, the central bank may want to ensure that the transmission continues and probably accelerates. Real interest rates could stay negative if one assumes that average inflation for the year is around 8% and so there is scope for monetary tightening. However, at this juncture, unless the inflation comes in at levels that simply cannot be tolerated, the subdued consumer and investment spends may just prompt the central bank may want to pause a little before re-starting its calibrated exit.