Dollar in doldrums: Its dominance weighs on us!

The fear of recession is looming large although the regulators tried to assuage concerns occasionally. Global investors go on a risk-off mode as they exit riskier emerging market assets including bonds and equities. They now only seek safety of dollar-backed securities. Last week, the Euro attained parity with the US dollar as the unit slipped past to 20-year low. Foreign portfolio investors sold a net of nearly $30 billion local assets this calendar year

US dollars are throwing emerging markets including India out of gear as surging interest rates are driving international investors away from riskier emerging markets. A perceived dollar shortage is gaining momentum amid a bout of dollar outflows.

Back home, there are concerted efforts to bring back dollars amid fear of looming recession in the US and Europe.

What happened to the dollar?

The dollar index, which measures the unit against world's major currencies, spiked 10.64 per cent versus a nearly seven per cent loss in the rupee's value against the dollar.

Since the Russia-Ukraine military conflict broke out on February 24, commodity prices surged springing higher cost of living. In the US inflation rose 41-year high while Europe too reported record high consumer price rises.

Central banks including US Federal Reserves and European Central Bank swung into action as they started winding up easy money policy.

US/Europe rate hikes to tame inflation

On June 15, the US Federal Reserve hiked interest rates by 75 basis points, fastest pace since 1994 to curb runaway inflation. ECB too hiked the benchmark rate by 50 basis points a few days ago for the first time in 11 years as the central bank sought to tame phenomenal rise in consumer prices.

Recessionary fear ceases EM opportunities

The fear of recession is looming large although the regulators tried to assuage concerns occasionally. Global investors go on a risk-off mode as they exit riskier emerging market assets including bonds and equities. They now only seek safety of dollar-backed securities. Last week, the Euro attained parity with the US dollar as the unit slipped past to 20-year low. Foreign portfolio investors sold a net of nearly $30 billion local assets this calendar year.

Pressure point

And this became a pressure point for the local currency. When overseas investors sell assets, they receive rupees. This in turn forces them to convert it in dollars, quintessentially putting pressure on the local exchange rate. Such a bout of dollar outflows pulls down the Rupee's value against the greenback.

The Rupee plunged to a lifetime low 80.06 per dollar on July 21. The Reserve Bank of India has been intervening in the currency market via dollar sales, which in turn depletes its record high forex reserves at $642.45 hit on September 3 last year. It has eroded by about $70 billion dollars.

Bring back dollars: A key mantra

While the Reserve Bank of India embarked on a five-point measures to shore up dollar stock, importers are seen scrambling for the greenback. Oil companies and diamond merchants were reportedly buying either dollar and currency risk covers, known as forwards/future contract in the currency derivative markets. The central bank also relaxed norms for potential overseas investments.

If dollars start coming back, it will increase demand for rupees adding to the strength of the local unit. Banks are now permitted to offer deposits to non-resident Indians without cap in rates. Although it is a limited period relaxation, large banks are now going hammer and tongs to lure Indians living in Singapore, Dubai, London and so on.

Ahead of US Fed policy on July 28

It is widely expected that the US central bank will again raise rates narrowing the rate differential between local and emerging markets. This in turn cuts risk premium for any global investor betting on India, Indonesia or Thailand.

It is to be seen how the US Fed defines future trajectory as the crude oil prices have dropped by about 16 percent from its peak of $124 per barrel.

Dollar dream

We can only expect it to be back once international investors wake up to the call of 'risk-on'. For this, the US Fed needs to end the rate hike cycle with inflation falling. Once the US is back on the growth track, risk appetite among investors will resurface, ballooning a beeline against emerging market investment like in India. This should also erase fear of recession both in the US and Europe.

Political turbulence

An unceremonious exit of UK's Prime Minister Boris Johnson following his colleagues' resignations in the cabinet is keeping Europe turbulent raising questions on Brexit.

A sudden assassination of Japanese former Prime Minister Shinzo Abe has held the country's stability hostage with the yen hitting 20-year low. Besides the Russia-Ukraine war, such unwarranted events only strengthen the greenback and its perceived safety. And, India is not immune to it, too! Dollar dominates.