Dollar index rise sparks FII selloff at home

If the rapid rise in the US Dollar Index (USDX) is anything to go by, the heavy selling in equities by foreign institutional investors (FIIs) can be attributed to the surge in the dollar appetite.

The USDX, a benchmark global dollar index traded exclusively on the Intercontinental Exchange platform of the New York Board of Trade (NYBOT), had hit a low of 71.33 in April 2008, before it rallied a massive 21 per cent to hit an 18-month high of 86.12 on October 22.

Interestingly, the FIIs who were net buyers prior to April 2008, except in the month of January when markets had crashed after the Reliance Power issue, turned net sellers and sold equity close to $8 billion in just six months from May. This forms over 70 per cent of the $11 billion equity sell-off by FIIs in the country so far this year.

 

Market players say many traders and fund houses across the world are buying dollars and shorting all other asset classes including equity, commodity and other debt-related instruments. This is because a three-year-long bear phase in the dollar was halted due to short squeeze this year. In a short squeeze, a large number of investors who have short positions in the asset try to close their positions simultaneously, requiring purchase of the asset.

The recent rally in the global equity markets was due to a sharp rise in commodity stock prices. Analysts say that while traders were long on commodity, they had shorted the dollar and other dollar-denominated assets. These shorts had created a lopsided market.

Apart from this, there was major pressure on the dollar from the colossal amount of credit in the US markets. Analysts explain that the problem with using credit is that it must be paid back. “Credit that is paid back drops out of circulation and is equivalent to a reduction in the cash supply. Credit that is defaulted takes more credit out of the system as it multiplies. So, more credit in the US system added short positions on the dollar as cash stays in circulation but credit money gets over quickly. This has caused dollar scarcity now, restoring demand,” said Deepak Sawhney, research head at Mumbai-based Networth Stock Broking.

However, the situation has reversed now as traders are selling equities and other assets to buy dollars and close their positions before they make huge losses on short-selling. Opportunistic traders are, thus, going long on the dollar.

Sachidanand Shukla, economist at Mumbai-based Enam Securities, says this is a temporary phenomenon. “The dollar is rising as other major currencies are falling. The rise in dollar may be attributing to the sell-off in other asset classes. But there are other reasons also,” he said. However, he accepted that equities and commodity-related stocks are likely to underperform as long as the rally in dollar continues.