Understanding the Relationship Between USD/INR and the Dollar Index
The US Dollar Index (DXY) is a crucial tool for understanding the dollar’s strength against a basket of six major global currencies, including the Euro, Yen, and Pound. When the DXY rises, it indicates the dollar is gaining strength compared to these currencies. For example, in 2021-2022, the dollar grew stronger, but from mid-2022, it entered a flat range before beginning an upward trend in September 2024.
Impact of a Strong Dollar on Global Investments
When the dollar strengthens, global investors naturally move their capital into the dollar to benefit from its rising value. For overseas investors holding Indian assets, this dynamic can create challenges. For instance, if the USD/INR moves from ₹82 to ₹86, even without changes in the Indian market, the depreciation of the rupee results in a 5% loss for these investors. This leads them to withdraw their investments, waiting for the rupee to stabilize before reinvesting.
RBI’s Role in Managing the Rupee
The Reserve Bank of India (RBI) often intervenes to stabilize the rupee. Between October 2022 and October 2023, the RBI kept the rupee within the ₹82-83.5 range, despite natural pressures for a 2-3% annual depreciation. Such interventions, while providing short-term stability, can lead to long-term imbalances. When compared to other emerging market currencies like the Brazilian Real or Mexican Peso, which depreciated by 5-10% against the dollar in recent months, the rupee’s minimal 2% fall has made it relatively overvalued.
Export Competitiveness and Currency Dynamics
India’s artificially strong rupee hurts its export competitiveness. Other emerging markets with cheaper currencies attract more business, as their goods and services become more affordable. Ideally, the rupee should have depreciated to ₹89-90 against the dollar to stay competitive. This misalignment creates challenges for exporters, making Indian products less attractive globally.
s and services become more affordable. Ideally, the rupee should have depreciated to ₹89-90 against the dollar to stay competitive. This misalignment creates challenges for exporters, making Indian products less attractive globally.
Impact on Investment Flows
The overvaluation of the rupee has created a deadlock in investment flows. Non-Resident Indians (NRIs) and other global investors are reluctant to invest in Indian assets at the current exchange rate. For instance, an NRI planning to buy property in India might delay their decision, anticipating a rupee depreciation to ₹90. Similarly, foreign portfolio investors are hesitant to bring in fresh capital when the rupee remains artificially high, fearing losses if it depreciates later.
Challenges for the Indian Market
This deadlock has slowed the inflow of much-needed foreign investments while encouraging capital flight. Additionally, India’s inability to align with the natural currency dynamics seen in peer emerging markets exacerbates the problem. A gradual and natural depreciation of the rupee would make Indian exports more competitive and restore confidence among global investors.
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