Implications of a stronger dollar: CARE Ratings

Analysis of the trend of a strengthening dollar and its implications by CARE Ratings

The strengthening of the USD in recent times has caused some element of volatility in the currency markets. From $ 1.37 per euro in December when the first tranche of tapering began to $ 1.36 in January, the dollar fell to a low of $ 1.38 in April, after which it has been strengthening quite rapidly, with acceleration in September, October and November, where it has come below the mark of $ 1.30/euro. The average level of $ 1.25 for November compares well with the levels attained prior to the financial crisis.

Impact on other currenciesWhile the movement of the currency for any country is dependent on the various factors that affect the balance of payments, there is prima facie reason to believe that some part of the movement can be explained by the stronger dollar. It should be mentioned here that domestic factors have also influenced such movements like the Russian ruble being affected by the Ukraine imbroglio. The table below gives the rate of change of the currency with respect to the dollar over April ‘14, after when the dollar started strengthening.

Lower cost of oil among other import items-

Given that other components of the external account like import of oil has benefited partly due to the strong dollar (The price of oil gets calibrated to the dollar and when the dollar falls, the price of oil increases and vice-versa) there would be some countervailing force to stabilize the rupee.

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The implication is that while the RBI has brought about order in the balance of payments and several components like imports, ECB flows, and FII funds, it would also have to constantly monitor changes in the external account on account of such changes in the currency value.

Given that this strengthening of the dollar is synchronous with the US recovery and likely increase in interest rates, it does need to be watched carefully.

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