With the European Central Bank’s latest move to expand its monthly bond purchase programme to €60 billion, the currency market is in turmoil. The euro has hit an 11-year low against the dollar, the dollar index is at an 11-year high. But the rupee is unfazed by this turmoil, holding steady at 61.5.

If we consider the year-to-date currency movement, rupee is among the strong performers; up 2.5 per cent. The Swiss currency tops the list, up 14 per cent thanks to the Swiss National Bank removing the cap on the franc’s movement against the euro. The Brazilian real is also up 3.22 per cent as that country’s central bank has raised rates to a three-year high of 12.25 per cent to combat inflation.

Stronger dollar

The focus is, however, on the US dollar, with the dollar index up 4.9 per cent so far this year. The slide in euro due to the threat of Greece exiting the euro zone, the SNB’s move and the continuing crash in crude prices have helped the dollar in two ways.

Rising risk-aversion due to the ongoing turmoil in financial markets has made global funds flow back into the safe haven of dollar-denominated currencies, giving the dollar a leg up. Since 57.6 per cent weight is given to the euro in the dollar index, the euro’s downfall has directly benefited the dollar.

Rupee’s strength

But a strong dollar is negative for the rupee, as is a fall in interest rates. Then why is the rupee strengthening despite the dollar’s strength and the 25-basis-point rate cut by the RBI last week? It is due to the high yields that Indian sovereign bonds are currently offering. The 10-year Indian government security currently trades at 7.7 per cent. This is the highest nominal yield among major countries, after Brazil.

If we consider the inflation-adjusted real yields, Indian G-Secs currently offer 2.7 per cent, far higher than 1.9 per cent real yield of Chinese sovereign bonds.

Declining consumer price inflation, coupled with policy rates still relatively higher at 7.75 per cent, has resulted in a widening spread between the real yields of India vis-à-vis other countries, making foreign investors flock to Indian debt instruments. While the equity market has received only $ 870 million, Indian debt has received almost $ 2.4 billion in the first three weeks this year.

This has led to a virtuous cycle where the flows are helping to bolster the currency and the currency strength is, in turn, attracting fresh inflows.

(With inputs from K Gurumurthy)