I have MacBook Pro M1 base model which I had bought 2 months ago. Now when I type with Caps lock off it types with small letters but when I press space key then type it automatically starts typing in capital letters.

I agree with @BDAqua. Your Mac is new and is under warranty. Take advantage of that while you can.

You can start here with an Appointment at the Genius Bar:

Genius Bar Reservation and Apple Support Options - Apple Support

Meanwhile, you might try connecting a USB keyboard to the Mac and see if that works to get you through a short period to work on your projects. If it does work, that's another reason to have your MacBook serviced.

One other thing to try is to see if the problem also happens in another user account. If you don't have another user account setup on your MacBook, go to System Preferences > User's & Groups and create one. Then login to that account and test the keyboard. If it works properly there, then the problem is with your regular user account and maybe we can troubleshoot more to see if it can be corrected.

If rebooting your Mac doesn’t fix things, see if the problem still happens in Safe mode. It can take much longer to safe boot (10 min) so be patient.

How to use safe mode on your Mac - Apple Support 

Start up a Mac with Apple Silicon in safe mode

• On your Mac, choose Apple menu > Shut Down.

• After your Mac shuts down, wait 10 seconds.

• Press and hold the power button on your Mac until the startup options window appears showing available startup disks and Options.

• Select a startup disk.

• Press and hold the Shift key, click Continue in Safe Mode, then release the Shift key.

Safe mode forces the OS to clear certain caches and logs and do other miscellaneous housekeeping. It's non-destructive to user data so is safe to do. Very often certain weird software behavior is corrected by simply logging in this way as a troubleshooting method. When you're in safe boot, the machine will not be at its best performance, especially with graphics, but that's expected.

Does the problem persist while in Safe mode?

Exit safe mode by restarting your Mac normally and re-evaluate the issue again.

If the problem is still unresolved, please return here and post a reply and we’ll see what else we can come up with for help.

Time to ask Apple for a repair. :(

I believe so. :(