The surprise that went soft.

The ability to surprise depends on two things. Expectations and preparedness. When you expect something or when you are too well prepared for an event, there hardly is any scope for a surprise. But, when you don’t expect much and are not prepared for something, the actual event should surprise. The RBI Guv’s move to drop interest rates by 50 basis points was something that caught the markets off-guard. It was clearly a pleasant surprise. The surprise surpassed all surmises of experts. Yet, the surprise did not manufacture much of a Wow. If the economic mood was what we had seen a decade ago, there would have been a big Wow factor in response to the surprise. This only shows the despondency in the economic mood in India and outside. The reason is simple. When borrowings are too high and earnings drop significantly, a drop in rates can’t do much to improve the state of affairs in business. Companies would get some benefits but not enough to significantly alter their fortunes. Effectively, if business was growing faster and showing strong demand for goods and services, a drop in rates like we saw this week would have made a big difference to profitability. But, companies can’t grow sales and their profits are reeling under pressure. This rate cut will only be a small relief to their mounting woes. Given the circumstances and the public mood, the RBI Guv did what he did. Not doing this would have set in wider gloom and visible dissent. So he did what he had to do. And, said as much that he wasn’t Santa Claus. That was the perfect give-away of how he sees things. We can’t really blame Rajan. We have a pile of past economic sins to exorcise. Leverage kills business. The only way over leveraged businesses are going to end their pain is through effective bankruptcy laws and strong, decisive action from lenders to take control of assets. Assets must be swiftly transmitted to solvent owners from insolvent ones. Interest rates coming down does not solve solvency issues. And, the most important problem gripping banking in India is the low levels of solvency among borrowers. A regulator of banking like the RBI can’t solve this problem. Government must find speedy ways to deal with solvency issues. Only then can lenders smile and markets give a big thumbs up. Till then, the murmurs will keep coming back.

I’m always fully invested. It’s a great feeling to be caught with your pants up. – Peter Lynch.

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