InvestorQ : Is the dollar the most important currency for India’s exchange rates?
Ria Roy made post

Is the dollar the most important currency for India’s exchange rates?

Mahil Khan answered.
3 years ago

That is largely true. The dollar is the most liquid and most used currency for India and for most other currencies in the world. That is why the dollar rate is the most important rate for any currency across the world. In fact, that is the currency benchmark. The INR is always expressed in terms of another currency. Normally, the most common benchmark is the US Dollar. Any weakening or strengthening of the dollar has a proportionate effect on the INR/USD exchange rate. For example, if the USD strengthens against the Euro, Pound and the Yen, then will the dollar appreciate against the INR too?

The exchange rate is largely dependent on the strength of the dollar which is captured by the Dollar Index (DXY). Even the impact of pound and Euro gets transmitted through the dollar only. The negative correlation is almost at par. Over the last five years, the Dollar Index (DXY) has appreciated and during the same period, the INR depreciated against the dollar. The relationship is almost a 1-on-1 relationship. The reason is quite simple. Most of India’s foreign trade and foreign debt is denominated in USD. Most of India’s ECB and FCCB flows as well as NRI deposits are denominated in dollars. It is, therefore, obvious that the dollar has an oversized impact on the rupee exchange rate. Hence any strength in the dollar index gets automatically transmitted to the INR/USD exchange rate in the same proportion and weakens the rupee proportionately.