A resurgent dollar causes global financial turbulence

Arshad Shaikh studies the historic fall in the value of the Indian rupee versus the US dollar. The resurgent dollar is causing a sharp decline in the value of most currencies in developing economies, and it is also impacting their equity markets and destabilising their economies. We need to understand the reasons behind this phenomenon and find ways to address the challenge of the slowdown in economies due to currency volatility and the fluctuations in the interest rates of the Federal Reserve. Neither crying hoarse nor burying our heads in the sand will solve the problem that impacts our everyday lives.

The Indian rupee continues to be battered by the US dollar. Last week, the rupee breached two hitherto untouched marks. It crashed to historically all-time low values of 80 and 81 to the dollar in the space of a few days. The rupee is trading at 81.48 at the time of writing, and chances are that it may decline even further. It has already lost more than 7% in 2022.

The only redeeming feature has been that this slump has been relatively less than the fall in other currencies. The Euro has dropped by 13%, the British pound by 11% and the Japanese yen by 16% against the American dollar. Consequently, the rupee has managed to appreciate against these currencies. The Australian dollar, Swedish krona, Chinese yuan, and Philippine peso have also fallen significantly in recent times.

The DXY or the dollar index is an important barometer to measure the value of the US dollar against a basket of currencies. Presently, the basket is made of the Euro, UK pound, Canadian dollar, Japanese yen, Swedish kroner and Swiss franc. The DXY is currently trading at 113 plus, a 16% gain since the beginning of 2022. This surge in the DXY is indicative of the massive rise of the dollar and the tremendous demand it commands in the global financial markets. 


Those at the helm of affairs in India cited different reasons for the drop in the rupee. While Finance Minister, Nirmala Sitharaman blamed the Ukraine crisis and the steep rise in crude prices; the RBI governor, Shaktikanta Das felt that the selling of assets and subsequent flight of funds to “safe havens” by the foreign portfolio investors (FPIs), in the wake of global monetary policy tightening was aiding the slide of the rupee.

The Federal Reserve (the American Central bank) hiked the fed funds rate by 0.75% in September. This was the sharpest hike since 1994. One of the key objectives of the Fed is inflation targeting (the current target is 2%).

The opening of the floodgates by the Fed to keep the economy afloat during and after the Covid-19 pandemic by injecting nearly 5.7 trillion dollars and maintaining the interest rate to near 0% since early 2020 resulted in an annual inflation rate of 8.6%, a 40-year American high. As business picked up and moved towards pre-pandemic levels, the Fed had no choice but to raise the interest rate notwithstanding the challenges it posed to the American as well as the global economy.

Some financial analysts predict a one-time hike of interest rates in November while the market consensus is that the Fed will go for a 0.75% rate hike in November, 0.50% in December and a final hike of 0.25% in March 2023.


Emerging economies such as India experience rapid economic growth compared to advanced countries such as the US and other Western European countries. Hence, they tend to have higher inflation and higher interest rates. The rates of interest in countries like the US and Japan have been very low or near zero. Naturally, foreign portfolio investors (FPIs) prefer to borrow money in the US at low-interest rates in dollar terms and then invest their funds in equities and government bonds of emerging countries like India in rupee terms to earn a higher rate of interest.

Thus, we have a positive stream of foreign portfolio flows into the Indian stock and bond market. This is known as carry trade and is in many ways responsible for the boom in our equity market. When rates of interest in the US start increasing, the carry trade is reversed. FPIs stop finding Indian bond markets lucrative and withdraw their funds from Indian G-secs (government securities) to reinvest in the US gold and treasury markets.

This reverse carry trade has two effects. One is that it causes a flight of funds from emerging markets or a global sell-off leading to a bearish market and depletion of a positive investment climate. Secondly, the Fed hike caused a slide in the rupee. As interest rates for dollar-denominated securities begin to move northward, the demand for the US dollar increases, it appreciates against the rupee, which keeps falling. This affects our trade deficit negatively.


A plunging rupee is politically inconvenient for any government in India. Somehow, it has acquired a correlation with the misgovernance of the currency. Hence, the country’s central bank is left with no option but to defend the rupee from further fall. However, this is easier said than done. To shore up the rupee, the RBI has to sell some of its hard-earned dollars. It did part with some of its war chest of foreign exchange. India’s forex reserves now stand at $537.5 billion as of Sep 23, the lowest in the last two years.

Defending the rupee cannot be a sustainable strategy because of our rising current account deficit (import-export gap). The complimentary requirement for RBI to accomplish this rescue act for stemming the flight of funds is to increase interest rates. However, this will reduce the domestic credit offtake, lowering investment and hence growth and development. Already the RBI has increased interest rates by 0.5% four times since May 2022.

There is a school of thought, which says that the rupee should not be artificially propped up. It should be allowed to “free float” and find its “market value”. The RBI should intervene only when the rupee encounters excess volatility in the exchange market. The “free floaters” believe that currency depreciation has its own stabilising effect. It makes imports expensive and boosts exports.

In fact, the RBI governor is on record saying: “Rupee is a freely floating currency and its exchange rate is market-determined, RBI doesn’t have any fixed exchange rate in mind. The RBI intervenes to curb excess volatility and anchoring expectations.”


Global investment is heavily tilted in favour of assured returns. Asset allocation models are divided into three groups: (1) The income portfolio where 70% to 100% of fund allocation is in fixed income investments like FDs (fixed deposits), G-secs (government bonds), corporate bonds, guaranteed plans and PPF (public provident fund). (2) The balanced portfolio where 40% to 60% of funds are allocated to stocks; and (3) We have the growth portfolio where 70% to 100% of investment is in stocks.

Again, the investment in the form of stocks is a betting game on the bourses where the highs and lows of a company’s fortunes are decided by “market sentiment” rather than “market fundamentals”. There is an acute need to move to rediscover the “real” meaning of equity. It means collaborating with business and standing by it in “good times and bad times”. It means becoming partners in business and sharing profits and losses.

Selling off shares at the slightest hint of a decrease in the “value of the stock” leads to financial instability that cascades to the real economy. Financial turbulence and volatility can only be curbed by moving to “real equity”. India must pioneer that transition.

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