To be sure, it may be a trifle early to talk about the economy overheating, but the HSBC Purchasing Managers’ Index (PMI) for manufacturing in March showed higher output prices. Suppliers’ lead times are increasing. The services PMI, too, showed prices charged hitting a new high for the current recovery.

Indranil Pan, chief economist with Kotak Mahindra Bank Ltd, points out that non-food manufacturing inflation, which was 4.3% in February, has risen to 4.7% in March. Non-oil imports are surging. Clearly, demand pressures are increasing.

Graphic: Yogesh Kumar/Mint

True, we may not yet have reached the limits of existing manufacturing capacity. But the capital goods part of the index of industrial production is showing high growth and, since monetary policy operates with a lag, it’s time for some pre-emptive tightening.

Liquidity continues to be abundant, with at least Rs50,000 crore parked in reverse repos. A hike in the cash reserve ratio is therefore essential before any rate hikes can have an impact.

Oil prices are another bugbear. Crude oil prices are hovering around $85 per barrel. This is what Kotak Institutional Equities recently had to say on oil prices: “The government may either let the companies set prices for auto fuels or may allow the oil companies to bear a large chunk of the under-recoveries. We note that the first option will result in higher fuel prices and inflation. The second is no longer an option—oil companies cannot simply bear such large under-recoveries without some sort of compensation from the government, whether cash or oil bonds. Both will add to the fiscal deficit, directly or indirectly. Even if the government was to deregulate pricing of auto fuels, it would still have to contend with high under-recoveries on cooking fuels."

And finally, the International Monetary Fund had pointed out three days before the rate hike in March that the policy rate was 2 percentage points below the neutral rate.

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