Why is the US dollar rising and rupee declining? Ex-CEA K Subramanian explains

Former Chief Economic Advisor K Subramanian on Monday explained why the US dollar is on the march, putting pressure on other currencies, including the rupee which has now crossed the 81-mark. He, however, said that the Indian currency has not done that badly if compared to other currencies.

Among the reasons the former advisor cited for the sharp rise in the dollar are - flight to safety, home bias, and rising dollar yields. 

"Why is the dollar appreciating? Combination of i) "flight to safety" where the US is considered a safe destination by investors; ii) "home bias" with the US being home for the majority of investors; and iii) dollar yields are rising and are expected to rise more because of monetary tightening by the Federal Reserve, the central bank of the US," the former CEA said in a series of tweets. 

The Indian rupee was hovering around 80 for quite some time but as the hawkish US Fed in its attempt to fight inflation hiked its policy rate by another 75 basis points, the currency slipped further and is currently at an all-time low of over Rs 81.   

Subramanian, who served as the CEA from 2018 to 2021, today said the depreciation of the rupee is less than all other currencies because of our stronger macro-fundamentals. This is also evidenced in significant FPI inflows since July with August inflow being the highest in 20 months. He said that all currencies have depreciated more year-to-date against the USD than the rupee. "While the rupee has depreciated 8% year-to-date, the dollar index has appreciated 18.8% over the same period," the former CEA added. 

The former advisor does not expect that the dollar strengthening will reverse any time soon. While the US economy is not doing well, he said the asset markets will do well in America. In fact, there may be a bubble building up in the US asset markets, he said. 

"Look at seasonally adjusted M2 (a measure of the money supply), July-22 is 5% higher than July-21. Compared to pre-Covid, M2 is still 40% higher. As this money is going into asset markets and the economy is in recession, the wedge between the real economy and money supply is growing wider," he said. 

So with this kind of wedge, he said the fear is that an asset bubble is building up in the US. For the next few months at least, till uncertainty about the Russia-Ukraine war doesn't subside, this bubble will grow from flight to safety plus home bias plus higher dollar yield, the former advisor said.  

Once the war uncertainty subsides, he expects the extraordinary amounts of money flowing into the US will stop and that's when the dollar appreciation will stabilize. Till then, he said all other currencies will depreciate, with the rupee depreciating less than other currencies. 

Subramanian has now been appointed as Executive Director for India at IMF.