Strength Of The Dollar Causes The Global Economy To Slow Down Even Further

Fri, Jul 8, 2022 12:29 PM on Economy, National, International, Exclusive,

The dollar is currently hanging near levels it hadn't seen in 20 years on the U.S. Dollar Index. It has increased by 8% since the beginning of the year and by 14% over the past 12 months.

The new steps taken by the Federal Reserve to tighten monetary conditions are likely to boost the dollar even further. The Fed's efforts to lower inflation are expected to involve ongoing interest rate rise.

What is the U.S. Dollar Index?

According to the Bank rate forum, the worth of the dollar in relation to six other currencies, as determined by their exchange rates, is measured by the U.S. dollar (USD) index. The U.S. Dollar Index expresses the value of the dollar in proportion to a "basket" of currencies, just like a stock index does for a basket of securities.

The USD index rises as the value of the dollar increases, and vice versa. A geometric weighted average of six different currencies makes up the index. Each weighting is unique since the size of each country's economy varies. The following list of nations is included, along with their weights:

  • Euro(EUR): 57.6 percent
  • Japanese Yen(JPY): 13.6 percent
  • British Pound(GBP): 11.9 percent
  • Canadian Dollar(CAD): 9.1 percent
  • Swedish Krona(SEK): 4.2 percent
  • Swiss Franc(CHF): 3.6 percent

What Takes Place When the Fed Raises Interest Rates?

The Fed aims to increase the cost of borrowing throughout the economy when it raises the federal fund's target rate. Everyone ends up paying more in interest payments as a result of higher interest rates, which increase the cost of borrowing for both businesses and consumers.

Projects requiring finance are postponed by those who are unable to make the higher installments. In order to receive larger interest payments, it concurrently pushes consumers to save money. The amount of money in circulation is decreased as a result, which tends to minimize inflation and moderate economic activity, or "cool off" the economy. The ultimate objective of the Federal government is to gradually reduce demand in the U.S Economy, which will allow prices to decrease and stabilize.

How Does the Higher Interest Rate Affect the Economy of Other Nations?

Though the Fed benefits from a rising currency by being able to control prices and encourage American demand for goods produced overseas, it also poses the risk of raising import costs for other countries, further escalating their inflation rates, and depleting their capital.

According to Clay Lowery, a former US Treasury assistant secretary for international affairs and current executive vice president at the Institute for International Finance, developing economies are at risk of a "currency mismatch," which happens when governments, corporations, or financial institutions borrow money in US dollars and lend it out in their local currency.

Tighter US monetary policy will have significant global consequences. Although the absence of alternatives is expected to maintain the dollar well-bid against almost all currencies, those with little to no interest rate support will be most acutely affected by the strength of the dollar.

In fact, this year has seen double-digit percentage losses for the euro, the Japanese yen, and the British pound because their central banks have either not raised rates or have not kept up with the Fed's vigorous policy tightening.

Given the difference in benchmark yields and monetary policies between Japan and the United States, the Japanese yen, which has underperformed the other major currencies this year by about 15%, is expected to remain weaker than 130 per dollar over the next six months. Likewise, the Sterling has lost over 12 percent of its value versus the dollar since the beginning of the year

What Impact Does the Indian Rupee Have on the Currency of Nepal?

The Indian rupee is in demand not only in Nepal but also in many other Asian nations due to its strength in the global market. Apart from the faster rate of economic growth since the 1990s, political stability was a tremendous asset for the Indian currency to keep its value relative to other currencies, however, recently its value relative to the dollar has also decreased.

The pegging agreement between the Nepalese and Indian currencies plays a significant influence in Nepal's development. Pegging Nepal's currency to a much stronger Indian Rupee prevents volatility and inflation. Because Nepal does not play a significant role in international trade, the Nepali Rupee would endure high volatility and inflation if it were a free-floating currency (like the US dollar, and the Indian rupee). The demand for Nepalese currency is significantly low, which will devalue its independent free-floating price. This leads to uncontrolled inflation, increased prices in foreign import goods and extremely low export prices.

The value of the Indian rupee in relation to the US dollar is determined by supply and demand. The value of the Indian rupee decreases when demand for US dollars increases and vice versa. The Indian rupee's current continuing depreciation against the US dollar, which saw a record low on Wednesday of 79.03, is also having an impact on Nepal's economy. In order words, the Nepali economy is a 1.6 one. That is, for every impact on the Indian Rupee, we get hit 1.6 times.

Since Nepal's currency is tied to India's, the decline in the value of the Nepali rupee is mostly due to the decline in the Indian rupee's value against the US dollar during the same period. In simple terms, it means that when the Indian currency is strong, the Nepali currency automatically strengthens and when it is weak, the opposite occurs.

In regards to the current economic status of Nepal, the trade deficit has increased by 25% (Mid July 21–Mid June 22), while capital flows, particularly FII flows (Foreign Institutional Investors), have decreased. In light of the US dollar index's ongoing rise, the Nepali rupee continues to fall as the dollar strengthens. To exchange one dollar, Nepalis must spend Rs 126.99 (Latest).