According to Care Ratings, while strengthening of the US dollar has caused volatility in the currency markets, FII inflows may provide cushion to the Indian rupee against a strong dollar

The strengthening of the US dollar in recent times has caused some element of volatility in the currency markets. Given that this strengthening of the dollar is synchronous with the US recovery and likely increase in interest rates, it does need to be watched carefully. However, if the current positive trend of foreign institutional investment (FII) inflows in equities and debt securities is sustained, it will provide some cushion to the Indian rupee, says Care Ratings.

It said, given that other components of the external account like import of oil has benefited partly due to the strong dollar, as the price of oil gets calibrated to the dollar and when the dollar falls, the price of oil increases and vice-versa, there would be some countervailing force to stabilise the rupee. "The implication is that while the Reserve Bank of India (RBI) has brought about order in the balance of payments and several components like imports, external commercial borrowing (ECB) flows, and FII funds, it would also have to constantly monitor changes in the external account on account of such changes in the currency value," the ratings agency said.

According to a research note, a stronger dollar, though good for the US economy would militate at the margin for its exports, though it is still considered to be a domestic driven rather than an external driven economy unlike some of the East Asian emerging markets. "But one consequence has definitely been that commodity prices have started coming down aided also by the low growth expected in countries like China which cannot be countered by the US recovery. China is the largest consumer of metals and prices have been moving southwards since August," the report said.

Talking about impact of stronger US dollar on other currencies, Care Ratings said, while the movement of the currency for any country is dependent on the various factors that affect the balance of payments, there is prima facie reason to believe that some part of the movement can be explained by the stronger dollar. It should be mentioned here that domestic factors have also influenced such movements like the Russian ruble being affected by the Ukraine imbroglio, it added.

According to the research note, there are two direct consequences of the stronger US dollar. The price of gold which bears an inverse relation with the strength of the dollar has moved downwards to below the $1200 per ounce mark. Traditionally gold is held as a substitute for the dollar as a safe haven. With the dollar becoming stronger, it said, a trend which will probably continue to move in this direction, gold has taken a hit along with other commodities.

"There has also been a flow of funds to the US now and a movement away from the other foreign bonds. This will have an impact in the coming months on the overall flow of funds to the emerging markets which benefited from both the QE programme as well a weak dollar," the report concluded.