Explained: What Does A Soaring Dollar Value Mean For India

India's concerns about inflation will grow as the cost of imports rises due to a stronger dollar.

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The rupee reached a new intraday low of 78.28 and ended for the first time below the 78 level. The Fed (the Federal Reserve Board which controls the U.S. government's central banking system) will be more active in its activity as a result of the US inflation rate rocketing to record highs of 8.6 percent in May, the highest level since December 1981.

This will increase the movement of capital out of emerging economies and put pressure on the local currency, raising the price of imports.

Why is the value of the US dollar soaring?

The US Dollar Index, which gauges the value of the dollar in comparison to six significant world currencies, recently surpassed its 20-year peak and is now trading at over 105. The year started at 96. The Dollar Index has moved higher as a result of three macroeconomic changes.

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Firstly, high energy and food prices drove US consumer price inflation, which had been slowly increasing since October 2021, to 8.6% in May 2022, its highest level since December 1981. An economy's interest rates typically catch up when inflation increases. The country's bonds become more appealing as a result, increasing demand for the currency. In a year, the yield on a US government bond with a ten-year maturity doubled, rising from 1.4% to 2.8%.

Secondly, the US Federal Reserve has gone into overdrive to combat inflation with rate rises in recent months after remaining in denial about how sticky it is until early in 2022. The Fed has increased its policy rates by 150 basis points since March. Market observers anticipate it to implement a second 75 basis point raise in July.

Thirdly, The tidal flood of cheap global money coming from these countries that propelled all risky assets from cryptocurrency to junk bonds to equities in the private and public markets has abruptly started to retreat as Western central banks have shut the taps to easy money and raised rates.

Effect on Indian Economy

Effect on the Indian stock market- The dollar weakens and the INR strengthens if the index declines and vice-versa. As a result, international investors in India have the chance to earn larger returns on their investments, but as of now the scenario is opposite. The Indian stock market may deepen and turn bearish.

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Foreign Investment- With a rising Dollar index, foreign investors find India a precarious investment avenue to earn higher returns on their investments. As such, FPIs/FIIs flow into the Indian economy and contribute to economic growth may suffer. The flow of capital to companies from their international joint venture partners goes up as FPIs and FIIs decrease. This can affect companies' growth and expansion.

Changes in metal prices- It has been historically observed that gold prices move inversely with the price of the dollar. So, if the Dollar index increases and the dollar appreciates, the price of gold would fall and vice-versa. This price movement of gold impacts the demand and supply of gold and, as such, impacts the Indian economy.

Fuel prices-Commodities for fuel and oil are exchanged in dollars. Since it imports more crude oil than any other country, India's economy is impacted by changes in the Dollar index. Crude oil and other commodities cost more when the Dollar index rises. As a result, import prices rise and India's current account is in deficit. Additionally, it has an impact on oil refineries, oil importers, and oil firms' bottom lines. If the Dollar index declines. This is very much evident as we speak.

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Inflation- The trend of Indian inflation is also influenced by the Dollar index. A rise in the dollar index strengthens the dollar and lowers the value of the rupee. A weaker rupee raises the price of imports and reduces India Inc.'s profitability by raising the cost of production. Cost increases cause inflation, which raises product and service prices to the detriment of customers. As a result, when the dollar gains, the entire GDP (Gross Domestic Product) is affected and slows down.

What is the near-term outlook for the US dollar and Indian rupee?

Fears of inflation escalating further and making the fight against rising prices challenging have been exacerbated by global geopolitical uncertainty brought on by a lengthy Russia-Ukraine conflict.

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Increased interest rates and a high level of global borrowing could trigger a recession. Although it may slightly slow down, inflation is not going away any time soon, as cited by Economic Times.

Quoting the aforementioned report, while according to bankers, imports will still be more expensive because billing is done in dollars and the majority of importers lack bargaining power, even if India's trading partner's currency has declined along with the rupee.

Therefore, most forecasts anticipate the rupee to continue losing ground against the dollar in the upcoming months, reaching 80 or even 81 levels as a result of the ongoing Russia-Ukraine crisis, rising oil costs, and the lack of any sign of relief from the FPI pullouts. However, if a conflict ends, oil prices drop, or FPIs start to unexpectedly see value in Indian shares at lower levels, such expectations could alter drastically very rapidly.