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What does the Dollar Index weakness mean for India?

Economy | Published on Jul 10th 2017 | Comment(s) 0
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A key highlight of the dollar has been its waning strength over the last few months. A variety of factors have been attributed to it like a reversal of the Trump Trade, cautious hawkishness from the Fed etc. But above all, it is also an indication that other economies are actually showing signs of strength. A weakening dollar index has important implications for India. But first, what exactly is the dollar index all about?

The Bloomberg Dollar Index (DXY) measures the strength of the US Dollar against a basket of hard currencies in the world like the Pound, Euro, Yen and the Yuan. The DXY was hovering around the 80 mark in mid-2014 and after the weakening of oil prices we saw a consistent strengthening of the dollar index to cross the 100 mark. But the real highlight has been the weakening of the dollar index in the last few months as is captured in the chart below…

The chart clearly indicates that the massive rally that we saw in the dollar index between July 2016 and December 2016 has almost entirely been given away. Why exactly has this happened? There could be 3 explanations for that…

Why has the dollar index weakened?

  • A strong dollar normally coexists with a hawkish monetary policy of the Federal Reserve. Over the last few Fed meetings, the Fed has been gradually toning down its aggression and hawkishness. The Fed guidance of just 25 bps more of rate hike in 2017 and 75 bps in 2018 makes the guidance much more dovish that originally anticipated.
  • One of the reasons for the strength in the dollar last year was the aggressive campaign carried out by Trump ahead of his election as the 45th president of the United States. His focus on cutting corporate taxes and investing $1 trillion in infrastructure had kindled hopes that GDP growth will come back to the US in a big way. However, Trump has disappointed in the last few months and a plethora of flip-flops have only made it worse.
  • To be fair, other economies are getting stronger and also planning less dovish monetary policies. The EU region has shown strength even as China is showing recovery in its PMI numbers. India appears to have come out its demonetization exercise largely unscathed. With ECB confirming that it did not see scope for further rate cuts, the Euro has been showing signs of strength. That has also resulted in the weakening of the dollar index.

What does weakening dollar index mean for India?

A weaker dollar can have positive implications for India. Here are a few such obvious benefits…

  • The big risk for India from a portfolio flows perspective was that portfolio investors could turn risk-off if the dollar strengthened further. In fact, many FPIs who had turned risk-off in favour of the dollar are now returning to emerging markets like India, South Korea and Taiwan. That is good news as far as Indian markets are concerned.
  • India owes billions of dollars in corporate debt raised through External Commercial Borrowings (ECBs) and Foreign Currency Convertible Borrowings (FCCBs). Both these products stand to lose when the dollar gets stronger. Some of the infrastructure companies in India were already under financial stress and a strong dollar would have worsened their financial solvency. This weakening of the dollar will come as a respite for them.
  • India still largely depends on imports to meet nearly 80% of its daily oil needs. Additionally, Indian has been running a monthly merchandise trade deficit of nearly $13 billion. A strong dollar would have only worsened the situation. Of course, one can argue that a strong rupee will mean liberal imports into India, but that is something the government can always regulate through a variety of defence mechanisms.
  • The only worry could be export oriented sectors like IT and pharma. Incidentally, both these sectors have underperformed even when the INR was weakening against the dollar. That is because there are larger problems plaguing these sectors like stringent regulations, greater competition and an underlying shift in the business model of these sectors. In fact, this dollar weakness will actually force these companies to look for more high-end opportunities and diversify their geographic concentration in the US.

The crux of the matter is that great expectations were built around the dollar and these became more pronounced after Trump took charge. This is, probably, a return to reality. For India, this will surely offer some temporary economic respite!




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