After the Dow Jones it will now be the turn of the dollar. In the past two weeks bourses the world over have been under stress. Now, the dollar is likely to add to the turmoil.
The dollar has been falling for quite a while not only against the euro but against many other currencies. In the last six months, the Brazilian real appreciated 11 per cent, Thai baht 11.5 per cent and the South Korean won 2.8 per cent. The Chinese yuan was kept fairly tied to the dollar and appreciated a mere 2.4 per cent. The Indian rupee, on the contrary, was left to the mercy of the market for fear of inflation and appreciated 9.4 per cent, causing many of the export industries considerable strain.
The Japanese yen had made a reversal because of the 'carry trade'. It had climbed down to 124 to the dollar in June. But in the last two weeks the dollar has been falling fast against the yen because, with the chaos in the mortgage market, the 'carry trade' nearly vanished. Consequently, the demand for dollars in Japan dropped and the dollar weakened against the yen.
The dollar will fall further for a variety of reasons. The US economy is slowing down with recession almost in sight. The housing boom is at its end with huge defaults in sub-prime loans causing havoc in the credit market. Industrial growth has dropped and unemployment has risen from 4.5 to 4.6 per cent. Trade deficit in the twelve months ending May has climbed to $ 827 billion. Inflation has eased but is still higher than in Eurozone.
It is against this background that the Federal Reserve decided on 7th August to let the interest rate stay put at 5.25 per cent and, from the assessment made by Ben Bernanke, Federal Reserve Chairman, may linger there for the rest of the year. That keeps foreign investment in US treasuries attractive if only the dollar does not weaken. The latter may be difficult because other economies are performing better.
In the European Union, GDP growth has picked up and is currently more than 3 per cent. Germany, the largest member of EU, is on the bounce. Growth is high, inflation is low, employment is on the upswing, trade is booming and the euro looks strong and safe. Many central banks are re-constructing their currency reserve portfolios with more investment in Euro securities and less investment in US treasuries.
There are good chances therefore that the dollar will fall against both the euro and the yen. It will not be long before the dollar will trade at 1.4 to the euro or 110 yen to the dollar. The rupee may not appreciate because the trade deficit has bloated, the limit on ECBs for domestic spend has been lowered and, with the slow down in the US economy and the chaos in the credit market, FII investment in India will taper down.
(The writer is president, RPG Foundation)