1. The standard format of the Modal dialog is overridden in the application Ruleset .The window size in Modal dialog window is selected to "fixed size" option in the radio button.
As the standard format was overridden to use fixed size and as it is not Auto (Fit to Content) , I have to create a new format for the modal dialog and choose window size as "Auto( Fit to content).
2. I tried changing the "standard format" (which is overridden in the application Rule set) from "fixed size" to "Auto(Fit Content) . After changing this I have applied the standard format for the modal in the "Launch local action". It worked perfectly fine.
So looks like the issue is with when a new format is created and "window size" option is selected as "Auto(Fit Content) .