FE Editorial : Dealing with dollar

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The Financial Express: Jan 01 2009, 00:56 IST

Financial instruments were the most important question of 2008. Currencies could well get that ‘honour’ in 2009. And the two most important questions for India, of course, are: what will happen to the US dollar, and what will happen to the Indian rupee. The dollar presents a paradox. The US was the epicentre of the crisis. Yet, massive capital flows came to the US in the aftermath of the crisis, driving up the dollar to unprecedented levels. These were related to a ‘flight to quality’. Investors worldwide were uncomfortable with holding credit risk and chose to buy US government bonds, driving down the interest rate on the 90-day treasury bill in the US to zero. In 2009, that flight to quality is likely to subside. Already, there are many signs of stabilisation in the financial system. The VIX, which measures the uncertainty of the S&P 500 index, has dropped by almost half to levels which would be considered high but not unbelievable in 2007. The 90-day Libor has dropped to 140, reflecting greater comfort on the part of the financial firms about each other. Interest rates in the US have dropped dramatically. Investors are itching to get out of US government bond investments. Once the panicked flight to quality is out of the picture, will money leave the US? While this is likely, it is important to keep the gloomy picture for the rest of OECD in mind. In continental Europe, Japan and the UK also, growth prospects are gloomy.

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