Dollar Index (often referred to as DXY) is a measure of the value of the U.S. dollar relative to a basket of 6 Foreign Currencies. It was created in 1973 with a Base Value of 100. The Dollar Index adapts to better represent the countries the U.S. buys from and sells to most. Foreign Currencies include Euro, Japanese Yen, Canadian Dollar, British Pound, Swedish Krona and Swiss Franc.
If the Dollar Index is 107, USD is 7% more expensive, which hurts emerging economies; in particular, an expensive USD puts pressure on their financial markets. If the Dollar Index is at 90, it’s 10% below its fair value, which will again hurt the emerging economy, as the majority of exports go to the US. It reached an all-time high of nearly 165 in 1984 and an all-time low of around 70 in 2007. In the years since then, the U.S. dollar index has been relatively range-bound, fluctuating between 90 and 110.
The index is affected by macroeconomic factors, including inflation/deflation in the basket’s dollar and foreign currencies, as well as recessions and economic growth in those countries.
An index value of 120 suggests that the U.S. dollar has appreciated by 20% against the basket of currencies over a particular period. Simply put, if the USDX goes up, it means the U.S. dollar is gaining value relative to other currencies. Similarly, an index value of 80, indicating a 20-point fall from its initial value, implies a 20% depreciation in strength relative to other currencies. The appreciation and depreciation results depend on the time period in question.
Impact in India
When the index falls, the rupee appreciates, and the dollar weakens. As a result, investors in the US see an opportunity for higher returns in India, leading to inflows of Foreign Institutional Investment (FII). Due to heavy inflows, there is heavy buying in the overall market, and the stock market turns bullish – goes up.
If we look at historical data, we can conclude that gold prices are inversely related to the dollar index value. When the dollar index rises and the dollar strengthens, gold prices will fall. Gold is imported into India in large quantities, which impacts the economy as a whole.
The change in the dollar index also affects crude oil prices. When the dollar index rises, crude oil and other commodities become more expensive. It increases our import costs and widens our current account deficit. It also affects the profitability of oil importers and refineries in India.
An increase in the dollar index strengthens the dollar and depreciates the Indian rupee. A weaker rupee makes imports costlier and affects Indian companies’ profitability by raising production costs. Increased costs for companies mean they have to raise prices on goods and services, which leads to inflation. The overall GDP is affected and slows when the dollar strengthens.
Some Indian companies have borrowed Dollar-denominated debt for cost-effectiveness. These companies are directly affected when the dollar rises. A strong dollar proves costly for companies with dollar-denominated debt, as they have to shell out more rupees to repay it. It impacts the company’s profitability and might lead to a financial crunch.
