strong dollar - for indian investors

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How strong dollar can impact investors in India?

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Page 1: Strong Dollar - for Indian investors
Page 2: Strong Dollar - for Indian investors

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 gains for the U.S.� The last six months have seen impressive gains for the U.S.Dollar versus the Yen, Euro, Emerging Market currencies.From the end of Jun14 till the end of Sept’14, 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.

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� 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.

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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.

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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, exports become moreforeign markets. For other countries, exports become morecompetitive 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.

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Dollar Index & Equities

There seems to be a very inverse relation between dollarindex and MSCI emerging market

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Historical perspective

Here, 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 between

dollar index and equity return.� However, when dollar index falls, the equity return is

still positive (instead of negative) and that could bebecause of corporate earnings growth. 7

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Relationship of dollar index vs.

MSCI Index and MSCI EM Index

Looking at probability of inverse relationship between dollarindex and MSCI (World as well as EM Indices) –

1) When dollar index falls, the MSCI EM index has shown higher1) When dollar index falls, the MSCI EM index has shown highernumber of positive returns vis-à-vis that of MSCI World index.

2) When dollar index rises, the MSCI EM index has shown highernumber of negative returns vis-à-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).

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FII Investment in India

We 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

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Dollar index & Commodities

� 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-politicaltension getting over.tension getting over.

� 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.

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Dollar index & Fixed 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 Indianmarket.market.

� 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.

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Conclusion� While, rising US interest rate along-with dollar

strengthening 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 affected the rupee asstrengthening dollar has not affected the rupee asfundamentals 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-term Indian 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. 12

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