Explained: Wanna know how low Rupee will go, see how high the dollar index goes

• The weakening of the Indian rupee is directly linked to the strengthening of the dollar index.
  
• The dollar index is a measure of the value of USD against a basket of currencies, most of whom are US trade partners.
  
• When the dollar index becomes stronger, investors tend to wind up their riskier investments from emerging markets like India.
  
• The dollar index, which has been range bound and under 90 for the last six years, however is the most sensitive to its own nation’s interest rates.
  

After the Indian Rupee hit the newest low of 80 per dollar, the question on everyone’s minds is where will it go from here? According to trade pundits, the answer to this question lies in the Dollar index.

The dollar index is a measure of the value of USD against a basket of currencies, most of whom are US trade partners. The US Dollar is appreciating against a bunch of other currencies as capital is leaving risky assets across the world and returning the US.

The weakening of the Indian rupee is directly proportional to the strengthening of the Dollar Index. The Dollar Index inched up to 108 and subsequently weakened the rupee — becoming yet another ‘imported’ macroeconomic pain point for the Indian central bank, which coined the term ‘imported inflation’. But what is the Dollar Index and why is it affecting us?

How did Dixie come to be?

The dollar index reflects the fair value of USD against a basket of currencies, most of whom are US trade partners. The greenback appreciates when interest rates rise on home ground. The Federal Reserve has been steadily increasing interest rates and this has resulted in a flight of capital from Emerging Markets like India back to the US.

When it was formed, it had many currencies but in 1999, a lot of them were subsumed into the Euro. Currently, the basket of currencies consists of six currencies – the Euro, the British Pound, Canadian Dollar, Japanese Yen, Swedish Krona and the Swiss Franc.

Informally referred to as the dixie, it was formed in 1973 after the US President Richard Nixon ended the gold standard, and turned it into a fiat currency – a currency that is not backed by any commodity. Around the same time, many other currencies like the Pound sterling became free floating where its value can fluctuate as per market events.

Why is it affecting the Rupee?

India too is a trade partner of the US considering its services export business, and hence has a trade surplus. Yet each of these currencies behave differently with each other because trade is not the only determining factor that determines currency values.

When the dollar index becomes stronger, which it has, in the recent past – rising over 108 – investors tend to wind up their riskier investments and plough them back into the dolar. Most of their riskier investments are from emerging markets like India and others.

FIIs have been ditching India for six months and a record ₹2.8 lakh crore flew out of the markets, stressing the rupee further.

In fact most investors globally have been taking money off former safe havens like gold back to the dollar, making the yellow metal hit a nine-month low this week. So much so that investors are worried that gold might be losing its status as an inflation hedge too.

How high will the dollar index go?

A lot of experts are of the belief that the dollar index could go over 115, inching very close to the 120 mark it had hit in 2001, a year after the dotcom bust.

“There has been a depreciation bias but now that it has hit 80 we see exporters coming to us and are seeing a bit of trader selling happening. But I think the dollar now is too strong and there is belief that it could go higher,” B Prasanna, group executive head of ICICI Bank, told CNBC India.

The dollar index, which has been range bound and under 90 for the last six years, however is the most sensitive to its own nation’s interest rates. After two rate hikes, the fact that US inflation has hit a 40-year high is sending jitters down the markets, with talk of a possible 0.75-1% hike in the horizon – something that might make it inch up – and sending the dominoes tumbling down – reducing the value of our rupee.

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