The Indian rupee has slipped significantly since Jan 2010. The trend was primarily driven by low FII inflows into Indian markets, rising USD against most global currencies, weak local equity market (due to weak corporate earnings). While the FII equity inflows remained flat the net debt inflow by FIIs saw a significant decline due to US treasury yields increasing to 2.05 per cent.
The U.S. dollar currently ranks as the best performing currency. The U.S. economy has recovered faster since the sub-prime crisis of 2008 thereby helping in strengthening of dollar. While the US GDP increased by ~4-5 per cent, the growth in Europe was marginal while Japan declined by a similar level.
As far as Japan is considered the quantitative easing measures has not shown the desired effect in stabilising the economy. On the contrary, the economy is still facing the problem of weak purchasing power, falling wage and increasing asset price. Under these circumstances any weakening in Yen will be a problem for the economy as imports will become costlier.
The dollar index which measures the value against a basket of currencies rose by 12% on a y-o-y basis while falling slightly by 1% m-o-m in April 2015. This was due to the fact that the US Federal Open Market Committee kept the interest rate unchanged at 0 per cent.
Dollar is expected to strengthen further in 2015. However first half of the year has been disappointing as the Fed didn’t signal a rate hike as the economy disappointed. Decreasing inflation, falling crude prices are keeping the inflation within comfortable limits thereby giving Fed some room to wait before hiking rates. It is possible that 2015 repeats a similar trend as seen in 2014 where there was a pullback in the first half of the year was followed by strengthening second half.
Factors determining currency movement:
- Trade balance: For higher imports (trade deficit) the currency of the country weakens
- Wealth: Reserve which can be gold, or cash. Factors which impact’s a nation’s ability to repay loans, or finance imports affect its currency.
- Budget deficit or surplus: Country with current account deficit has weaker currency than one that runs on surplus.
- Interest Rates: Funds are transferred depending on interest rate. If interest rate of country A is lower than interest rate of country B, the funds (keeping everything constant) would flow out from country A.
- Inflation: If the inflation is high with return on investment being low the currency of the country depreciates.
- Political factors: Tax, subsidies, political stability etc. affects the international trade thereby changing currency valuation.