The difficult question is what to do about the “overheating” if it is indeed happening. While on the one hand, raising interest rates would help contain inflation, on the other, it would slow down growth.

However, despite the danger of being accused of spoiling the party, keeping rising inflation in mind, in recent months the RBI has taken a number of steps to tighten monetary policy.

Interest rates — the repo rate and the reverse repo rate — have been raised and the Cash Reserve Ratio has been hiked.

This would suck liquidity out of the banking system and reduce the availability of credit making it more expensive to borrow. But the latest inflation numbers may not necessarily mean that more interest rate hikes may follow immediately. The impact of interest rates on inflation is never instant. It usually happens with a lag. The tightening done by RBI may not have an impact on prices for up to six months. Usually a gradual approach that gives a clear signal to the market that the Central Bank is prepared to raise rates if inflation continues to go up is more effective than a sudden sharp rise in rates. Interest rates are important in giving signals to markets and therefore in curbing inflationary expectations.

Until recently, the impact of higher rates on actual credit availability and bank lending in India was low because banks were holding more government securities than they are required to. To increase lending, they merely had to run down their stock of government securities. Thus, demand for credit for investment or consumer expenditure could be easily met.

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