Economy
For a few $$ more: Signals from the rising greenback
Summary
- The US Dollar has continued to rise this year. What are the implications?
The dollar is having an unusually strong year, gaining against most major currencies. That’s got policymakers from Tokyo to London fretting over its implications for economies. Mint takes a look at one of the most important price signals of the global financial market:
What is happening with the US dollar?
The US dollar, the world’s de facto reserve currency, has been gaining strength since the beginning of this year. A currency is considered “strong" when it rises in value against other currencies in the global foreign exchange market. The ICE US Dollar Index, which measures the greenback against a basket of six major currencies, is up around 4% in 2024 so far, though it is still some distance away from the levels witnessed in the early 2000s. The dollar has gained against almost every major currency this year, an unusually strong trend which demonstrates its primacy in the global financial system.
What is causing the dollar to strengthen?
The primary reason is that the US Federal Reserve, the country’s central bank, is keeping interest rates at over 20-year-high levels as inflation is still above its target of 2%. The central bank, earlier this month, left the benchmark interest rates unchanged at 5.25 - 5.50% for the sixth straight meeting. Higher interest rates mean American assets like Treasury bonds offer better returns than most of the world—and that too at virtually zero risk. US equity markets too are trading at lifetime peaks. These factors have triggered a gush of foreign fund inflows into the US, strengthening the greenback.
How does this impact the rest of the world?
A stronger dollar means the currency on the other side of the trade is weakening. Two-thirds of 150 currencies tracked by Bloomberg have weakened against the dollar this year, including the euro, rupee and yuan. This raises the cost of imports as global trade is dollar-denominated. Key commodities like oil are priced in dollars, stoking risks of imported inflation.
What does this mean for India?
Since India imports 85% of its crude oil, a weaker rupee is a major risk to its economic health. The Reserve Bank sells dollars to prop up the rupee, but there’s a limit to its firepower. India’s foreign exchange reserves declined for the third straight week to stand at $637.922 billion in the week ended 26 April. A strong dollar also affects companies with dollar-denominated debt as they have to pay more in rupee terms to repay their dues. However, a firm greenback boosts the revenue and margins of exporters.
What is the near-term outlook for the dollar?
A resilient US economy, as seen in strong inflation and labour market data, has dimmed the prospects of the Federal Reserve easing its stance any time soon. Investors are pricing in interest rate cuts of just 50 basis points in 2024, compared to projections of 150 bps at the start of the year. Ratcheting up of geopolitical tensions has further boosted the safe-haven appeal of the US dollar. Against this backdrop, analysts say, the greenback is expected to maintain its upward trend at least till the second half of this fiscal year.
