#dollar #gaining #strength #rupee #weakening
Rupee weakening or dollar strengthening. What is the difference?
When the equilibrium in the exchange rate is disturbed because of domestic factors like inflation or current account deficit, it is the rupee that is said to be weakening. However, if the drivers of change are global factors with money flowing into US dollar assets, then the dollar is said to be gaining. In this year, the dollar index, which measures the performance of the greenback against a basket of currencies, is up over 14%, while the rupee’s fall is at about 10% (see graphic).
For citizens of most countries, exchange rate is not a big deal and nations like Japan and China actively try to weaken their currencies to help businesses export more. In India, a weak rupee has always been seen as a pointer to economic woes. For instance, if there is runaway local inflation, the domestic currency gets debased as you need more rupees to buy the same quantity of goods and services.
India has always had a trade deficit thanks to our fetish for buying gold. The trade shortfall has been largely made up by capital flows from foreign investors buying shares, which has helped maintain balance of payments (foreign currency coming in and going out). The rupee tends to come under pressure, when this balance is not maintained.
However, exchange rate is also impacted by global factors. Globalisation has meant that trillions of dollars can move across borders driven by fear and greed. Currently, funds are moving back to the US, chasing higher interest rates amid fears of geopolitical uncertainty. This has led to the dollar gaining against most currencies.
What difference does it make to you?
It does not matter whether the rupee falls or dollar gains for those booking hotels and airline tickets online as they will end up paying more in both the cases because settlement on most digital platforms is in the US currency. But for tourists purchasing non-dollar foreign exchange to spend locally, most places outside the US are cheaper. Also those sending their children to study in the US will have to spend more, but costs are lower for universities in the UK and Europe.
If many currencies are depreciating, why is dollar so important?
Irrespective of countries involved in trade, most billing and payments happen in the US currency. It is the most stable and liquid currency. Also, given the size and liquidity of the US financial system, most countries maintain their savings (foreign exchange reserves) in the dollar.
If most imports are in dollar, how does it matter what the exchange rate drivers are?
For a trader buying dollar, there is no difference. But if you are an importer buying from a hard currency market like Germany, you can get a better deal by paying in euros as that has become cheaper. For an importer buying from China, there is an opportunity to bargain as the yuan has weakened more than the rupee. However, the ability to bargain also depends on the seller’s pricing power. The chance of getting a bargain is more for commodities and goods in ample supply. For items like oil, bargaining power is less as pricing is not derived from bilateral negotiations but are instead market-driven.
Is this better than a weakening rupee situation?
The current situation is better in the short term but not in the long run. In a strong dollar situation, risks to financial stability are not as high as when there is a run on the rupee. The flip side is that when international factors drive the rupee, solutions may not be in control. Also, if the current situation persists for a long time, exchange rate drivers will cease to matter, and the economy will suffer.
What can government do when exchange rate is driven by global factors?
A key change the government is working on is the shifting of trade billing to non-dollar currencies and internationalising the rupee. The dollar share in trade invoicing has decreased to about 85% from over 90%. Borrowing by corporates in ‘masala bonds’ (international debt where returns are similar to an investment in rupees) reduces exchange risks. Ultimately, there is no alternative to maintaining a balance of payments and having a healthy current account.