The American dollar is the most traded and prestigious currency in the international market. Countries worldwide equate their currencies against dollars, as the dollar is the most preferred currency in international trade. This equalisation helps countries determine their currency value against the dollar, calculated through supply-demand forces in the international market.
Demand and supply is created by various participants ranging from central banks, individual participants, financial agencies, multilateral agencies etc. An example of individual participation is when foreigners demand the currency to travel, study, invest or buy goods and services. Another instance is when a country’s central bank interferes by buying or selling the local currency or dollars, thereby creating or destroying artificial demand/supply in the international market to prevent any sudden fluctuation in the exchange rate. Notably, the exchange rate is the most observed rate by experts and macro players, which affects domestic and international participants’ decisions.
The graph depicts the exchange rate fluctuation of the rupee value vis a vis the dollar. It is a quarter-wise comparison from 2022 to the recent quarter.
As the graph shows, in January 2022, it would take 73 rupees to buy one dollar, which currently stands at 83 rupees. While multiple factors affect the exchange rate, the article will mainly focus on the impact of the US Federal Bank rate hikes and the rising oil prices due to the Russian-Ukraine war as these are the prominent factors affecting the dollar-rupee exchange rate.
In Quarter-4 2022, the rupee touched 82.78 per dollar, an upshot of 11.03% from the first quarter of 2022. This is the most significant annual decline since 2013. The apparent reason for this upshot was the US federal bank stance of continuous strengthening of monetary policy. Countries globally have witnessed elevated inflation partly due to reckless money disbursement during the covid-era or the supply-side disruption due to geopolitical conditions. The US attempts to strengthen monetary policy- a rising interest rate that will eventually decrease the purchasing power of the citizens, thereby taming the rising inflation due to excessive demand. The bank has raised the rate from 0 to 5.25%.
When the Federal Bank increases interest rate, investor around the globe withdraw their investments in domestic markets and put them into the US Federal Bank bonds, as it is considered as the safest investment alternative during difficult times. In this process, investors demand dollars and sell rupees, which subsequently leads to an appreciation of the dollar and a depreciation of the rupee, respectively. The depreciation of the rupee makes it worse for the existing investors against the continuously appreciating dollar, leading them to withdraw the investment making it even harder to prevent the rupee from falling further. This prompt withdrawal in investment is a consequence of the falling real value of their investments.
Further, oil is traded and settled in dollars. India imports 80-85% of its oil from middle- east countries. With an appreciating dollar, India has to pay dollars for its oil imports, which depletes India’s forex reserve. A low reserve impedes RBI’s market participation in the international market as it limits its ability to stabilise the exchange rate of the falling rupee.
Market experts fear that this sentiment may persist for longer if the fed keeps hiking their interest rate—a statement by Raj Deepak Singh, head of derivatives research at ICICI Securities