A dirty market will always be volatile.

For months politicians, stockbrokers and business fellows have been begging for a reduction in interest rate but when the RBI cut repo rate by 25 basis points to 7.25% yesterday the market fell by over 600 points. So far the interest rate has been cut 3 times this year, from 8% to 7.25%. Apparently the rate cut was already factored in, so there was a collective shrug when it actually happened, the government announced a reduction of monsoon rains to 88% of normal and the RBI expects inflation to creep up towards 6% by next year, which means that there is no scope for further cuts. One enraged broker said that to think that the RBI can control inflation like the Federal Reserve does in the US is a " dangerous line of thought ". In his opinion the RBI should not have increased interest rates in 2011 and should have cut more aggressively this year. Which means that the RBI's sole function is to support the stock market so that share prices keep on rising infinitely. Somewhat like the voodoo economics espoused by Turkey's President Erdogan who thinks that lower interest rate will lower inflation and not reducing rate is betrayal. Other writers are questioning the RBI's logic of reducing rate when it foresees rising inflation. The fall in share prices may have been an overreaction but Indian companies are being downgraded because earnings growth is weaker than predicted. Earnings growth is weak because consumer spending is suppressed and will only improve if inflation stays low. This is mostly in the hands of the government and there is nothing the RBI can do about it. The Service Tax rate went up from 12.5% to 14% yesterday which will add to bills, from cell phones to restaurants. Some politicians want a weaker rupee to increase exports but that will increase the price of imports, especially oil. It is no point comparing with China, Japan, Europe or the US, all of which have inflation at lower than 2%, whereas the Congress scorched us with retail inflation at over 10% for years, while it went on an irresponsible spending spree to bribe voters. One reason why our market is so volatile is because Indians have reduced their exposure to equities by half in the last 15 years. Only 2% of total household savings are invested in the stock market. Retail investors tend to hold on to their portfolio and hence provide a stability to the market, but Indians have a deep distrust of stocks. They are wise because promoters of companies are pledging their shares to banks to raise money. Banks lend a portion of the market value of shares and if the price falls they ask promoters to make up the difference in cash or sell them off. Forced sale in a falling market exaggerates losses. Unless our market is cleaned up people will stay away. Whatever the politicians and brokers may say.