Nomura on Tuesday see a 35 percent probability of rate hike in October by Reserve Bank of India (RBI).

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In an interview to CNBC-TV18, Sonal Varma, chief economist, said that food inflation has been under-shooting expectations.

Watch the full interview here.

Verma said that forward looking expectation is that growth is actually going to slowdown, "So, if that happens, you do have input cost pressures because of oil and currency. "

Edited excerpts:

Q: The consensus view is that there will be another rate hike in the October policy, but what then? Does the door open for more rate hikes now if the risk conditions deteriorates further, because it looks like the macros are going to worsen from here?

A: The October meeting is not a done deal yet. If you look at simply from the growth inflation and particularly from the inflation prism, inflation is actually tracking significantly below the Reserve Bank of India's projected path of 4.6 to 4.8 percent. We could easily see an under shoot of 50 basis points relative to those projections, despite the adverse shock from rupee and oil. So, purely from the growth inflation metric point of view and the fact that RBI did front load hikes, I don’t think October is a done deal. But having said that, one month is actually a long time in these markets now and what we are basically saying right now is that yes, at the margin, the probability of an October hike has gone up. We are assigning a 35 percent probability to it and whether the RBI and the MPC pulls the trigger or not, honestly will depend on how things pan out in the next one month. It's not a done deal either way.

Q: I am a little intrigued, you have not changed your inflation forecast for March end? Don’t you think in the October policy the RBI will come with a new inflation forecast for March end? I don’t think they have factored in rupee at 72 per dollar when they were giving their inflation forecast, did they?

A: They did not. I think at that point in time, we were closer to 67-68 levels and of course what they have said in the past is that every five percent depreciation adds about 20 basis points or so. So one can do the math in terms of the inflationary shock that might come in. At the same time, I mean there are lots of moving dynamics. So on the food side, despite the expectation for various reasons, food inflation will pick up month after month and we are seeing food actually undershoot expectations.

Second, I was actually surprised that the manufacturing Purchasing Managers’ Index (PMI) did not show either input or output price indices picking up despite the currency depreciation. Maybe that shows up with a lag, but as of now, there isn’t a pressure, which is a bit surprising of course.

Third and more importantly, we are sitting at a peak of the growth cycle right now. Our view was that in the last 6-12 months India would see an inflationary recovery and that has sort of panned out. Sitting here at 8.2 percent GDP growth, I think a lot of factors now are moving adverse, whether domestic or global and therefore, the forward looking expectation is that growth is actually going to slowdown. So, if that happens, then, you do have input cost pressures because of oil and currency. On the counter, you have food, which is sort of under checked and the demand, which should actually be lower incrementally in the coming month. So, if we put all those factors together, I don’t think just the currency impact can be imbibed. You look at the aggregate picture, I think there isn’t a case for inflation to overshoot the projections.

Q: Consumption expenditure has just about started to pick up. We have seen some nascent signs of recovery and if we do get this third successive rate hike, then it could sort of kill that nascent pickup that we are seeing in private consumption expenditure because we have seen it happen in the past? Do you also fear that?

A: I mean there are two points’ aspects of what you are saying. One, in terms of consumption has just started to pick up. The growth cycle itself has just started to pick up after the twin shocks. But if you look at India’s growth cycle over the last 5-10 years, it has largely been a consumption driven. We actually haven’t seen much in terms of investment at all. So, one should be fearful on growth side. I think one should be more fearful of investments not picking up and not consumption I think that has been reasonably strong.

Two, your second question in terms of the impact that rate hike will have on demand in general, unfortunately, as an importer of global capital, we are price takers and 2.5 percent or 3 percent current account deficit is actually okay. We are not sitting at levels of 2013, but the global risk environment is extremely adverse and there are number of reasons from the trade protectionism to the normalisation in developed market monetary policy to a growth slowdown that we think will start to feed into emerging markets as well. While the sentiment might stay adverse, so as a current account deficit country we have no option. Either we look to implement measures that can encourage more capital inflows, if not then, we need to squeeze down our demand otherwise it is going to have macro implications.

So unfortunately, the external environment has turned significantly adverse and that requires India to slow down its domestic demand at the margin. Now, that can happen through monetary policy or it can happen through fiscal consolidation as well.