Strong Dollar - for Indian investors

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How strong dollar can impact investors in India?

Text of Strong Dollar - for Indian investors

  • 1. Dollar strength a million dollar question There is divergent stance by central banks globally incontext to monetary easing with US and UK Central bankson one side and Japan and European Central Banks on otherside. The last six months have seen impressive ggaaiinnss ffoorr tthhee UU..SS..Dollar versus the Yen, Euro, Emerging Market currencies.From the end of Jun14 till the end of Sept14, the dollarindex which is composite index against six major currencies(Japanese Yen, Swedish Krona, Swiss Franc, CanadianDollar, British Pound and Euro dollar) strengthened by7.7%, during the same period. Potential impact include: import inflation in Japan andEurope, higher global commodity prices quoted in USD.

2. These are strong moves exhibiting increasingmomentum. If these trends are reinforced, it willchange the existing dynamism in global financialmarkets. With higher interest rates as indicated by FOMC, USDstrength is likely to persist; however, we expect that itwill proceed at a more moderate pace in future. 3. Reasons for the dollar's strength Strengthening of US economy (both, in absolute andrelative terms) Stronger US growth and higher interest rates makes theUnited States a more attractive location for investments;prompting the buying of dollars Federal Reserve moving toward withdrawal of liquidity Policy normalization vs other global central banks notablythe European Central Bank (ECB) and the Bank of Japan(BoJ), which are still aggressively easing policy Shale gas US energy renaissance means improving US trade/currentaccount balances; possibly leading to a shortage of dollarsabroad and thereby dollar strengthens. 4. Impact of a stronger dollar Higher global commodity prices (quoted in dollars), as thedollar appreciates, commodities become more expensive foroverseas buyers, who have to convert their weakercurrencies into dollars; curbing global demand. Makes US exports more expensive and less competitive inforeign markets. For other countries, eexxppoorrttss bbeeccoommee mmoorreecompetitive as their currencies depreciate. In USA, lower import prices (e.g., oil and autos) leavesmore discretionary spending power in hands of US residents Higher purchasing power for Americans and hence spendingincreases. Money earned in foreign currencies is worth less, whenconverted back into dollars. Hence talent moves back toUSA. Remember, US always preferred dollar supremacy. 5. Dollar IndexEquitiesThere seems to be a very inverse relation between dollarindex and MSCI emerging market 6. Historical perspectiveHere, average of annual return of MSCI equity indices arecompared with dollar index. Two scenarios are considered when dollar index falls and when dollar index rises. Prima facie, there is an inverse relationship betweendollar index and equity return. However, when dollar index falls, the equity return isstill positive (instead of negative) and that could bebecause of corporate earnings growth. 7. Looking at probability of inverse relationship between dollarindex and MSCI (World as well as EM Indices) 1) When dollar index falls, the MSCI EM iinnddeexx hhaass sshhoowwnn hhiigghheerrnumber of positive returns vis--vis that of MSCI World index.2) When dollar index rises, the MSCI EM index has shown highernumber of negative returns vis--vis that of MSCI World index.That means, global institutional investors prefer to flock todeveloped markets, when dollar index rises (risk off climate)and towards EMs, when dollar index falls (risk on climate). 8. FII Investment in IndiaWe believe, if dollar index continues to rises, there could bevolatility in equity indices and specifically so for EMs.In fact, FII investment in Indian equities has started slowingdown. 9. Dollar indexCommodities The rise in dollar affects commodity prices. However, rising dollar is not the only factor behindcorrection in commodity prices. Crude oil prices, for example, has come down because ofhigher production in the US and with major geo-politicaltteennssiioonn ggeettttiinngg oovveerr.. Prices of commodities of industrial use have come offbecause of softening growth in China. As a net importer, lower commodity prices are good forIndia. Lower crude oil prices, for example, will not only helpto check the current account deficit, but will also help tokeep subsidies and fiscal deficit under control, which augurswell for the Indian economy in general and stock markets inparticular. 10. Dollar indexFixed Income Things can get a bit complicated, if rates in the USA beginto rise sooner than anticipated. A policy path of the Federal Reserve will remain importantfor the Indian market as quicker-than-anticipatedturnaround in policy may lead to volatility in the Indianmmaarrkkeett.. It is also important to note that compared with the equitymarket, debt market, which is more sensitive to bond yieldmovements in the US, has seen higher flow of foreigncapital in the recent months, in Indian debt market. In 2013, when the Federal Reserve, for the first time,indicated that it will reduce the quantum of asset purchase,it was the debt market which witnessed outflows andcontributed to currency volatility. 11. Conclusion While, rising US interest rate along-with dollarstrengthening is an important aspect to keep a close watch. We believe that this has already played out larger part forthe time being, and same could be of concern if US startsrising interest rate mid of CY2015. Indian economy has strengthened in past one year. Thestrengthening dollar has not aaffffeecctteedd tthhee rruuppeeee aassfundamentals have improved. Further, in terms of foreign fund flows, India will remainbetter placed as economic activity in commodity-exportingemerging economies such as Brazil, Russia and South Africaare likely to remain subdued because of softening prices. Overall, things are unlikely to change much for the long-termIndian equity investor as value of the US dollar isunlikely to affect domestic fundamentals. Volatility andshort-term corrections can be used to increase equitythrough quality funds and stocks.