The US dollar has rallied over the past 11 weeks. The dollar index is now at its highest level in four years. Much of this is because US monetary policy could be getting tighter next year as the economic recovery there consolidates, while it will continue to be extraordinarily loose in Japan and Europe because of persistent deflationary risks.
The Indian currency has been remarkably steady despite the dollar’s rally, compared with its sharp decline in the middle of 2013. The divergence is largely due to the progress since then in reducing economic imbalances.
Several other asset markets have established correlations with the dollar index. Two are worth mentioning here: oil and gold. Prices of these two commodities tend to fall when the dollar rises. We have already seen signs of this in recent weeks. Indian policy makers will be watching if this trend continues because they lie at the root of the twin deficit challenges.