From India's perspective, a decline in the dollar against the major currencies invariably means appreciation for the rupee.

On July 18, last Wednesday that is, most currency traders I know went home from work a little later than usual. They lingered in their dealing rooms until the late hours of the evening, waiting for the first tickers on US Fed Chairman Ben Bernanke's testimony to the US Congress to appear on their Reuters and Bloomberg screens. As the tickers flashed and the reports unfurled, there was a deep sense of foreboding all around.

The US central bank's top boss' assessment of the economy was cautious in true central banker style but was underpinned by a sense of gloom. The key message was that the US economy was likely to do a little worse than predicted earlier. The problems in the housing sector were worse than anticipated and the contagion was spreading to the broader economy.

The testimony would, most traders and analysts fathomed, do little to stem the unabated fall of the dollar against the euro and pound sterling over the last month. The dollar, which had lost about 5 per cent against the pound and the euro this year, was perhaps due for another drubbing. The once invincible greenback would perhaps look a little more enervated, its sheen a little duller.

For most currency market players, the dollar's decline is a simple matter of interest rate differentials. The euro-zone economies and the UK are growing faster than the US, breeding inflationary pressures in the process. Thus the chance of their central banks hiking their policy rates is higher than that of the US Fed tightening monetary policy.

In fact, if the US economy slows down a little more, the central bank might even be forced to cut rates. If the euro-zone and UK offer higher interest rates, capital will flow from the US to these markets. The demand for dollars would wane further and the exchange rate would be the obvious casualty.

However, the frenzy with which investors and traders have dumped dollars in the last few months suggests that their decisions are based on more than just interest rate differences. There is, after all, an exchange rate level at which these differentials (both current and expected) would get "priced in".

In the recent bear phase, the dollar's value seems to have plummeted quite a bit below this level.

My sense is that the markets are finally coming round to the view that the consequences of the large macroeconomic imbalances that have festered in the US over the last few years are finally coming home to roost. A process of deep structural correction (that the US managed to avoid in the past despite the dire prognosis of economists) is finally beginning to set in.

If these structural adjustments were to continue, the "dollar aversion" that goes with them could take the currency to unprecedented lows. In short, the dollar's behaviour is about more than just the simple arithmetic of interest rate differentials.

Let me be more specific. There are two distinct areas in which the correction that I mentioned earlier is beginning to manifest.

The first is clearly the imbalance in the finances of US households. US consumers have, over the past few years, kept the growth clock ticking by funding a spending binge through a combination of leverage and wealth expansion driven by asset inflation. Their savings have virtually come down to zero.

The housing sector played a key role in this. Low interest rates pushed up house prices and household net worth, creating a positive wealth effect. US consumers have used their homes as their ATM machine borrowing -- via Home Equity Withdrawals -- against their rising home wealth to finance negative savings (an excess of consumption over income). HEW reached $579 billion in 2005 or about 10 per cent of disposable income.

A number of economists have pointed out that this was unsustainable since any turn in the interest cycle would turn off this cash spigot. This is precisely what is happening now -- the deceleration in the mortgage market is unlikely to remain confined to the housing construction sector alone.

It is spilling over to retail spending across the economy and threatens to rein in growth for a few years to come. Thus apprehensions of a drawn-out deceleration in the economy are likely to keep the sentiment towards the dollar weak.

The other macroeconomic imbalance that seems to be correcting now is the current account deficit (broadly the balance of trade in goods and services along with income transfers). Going by any conventional measure, this has appeared completely unsustainable for a few years.

Recent months have seen some compression but the deficit is still in the ball-park of about 6 per cent of GDP. The only way a current account deficit can shrink is if exports go up and imports shrink. That again calls for a substantial depreciation of the US currency, a possibility that currency traders appear to be pricing in with a vengeance.

How long will this dollar bearishness persist? That depends on how long these corrections take. If, for instance, exports start perking up sharply and the trade deficits shrink at a rate faster than anticipated, the dollar could take a breather on its downward journey and even gain some ground against other currencies.

If the process lingers for a while, the risk of central banks across the globe shifting a significantly larger fraction of their foreign exchange reserve portfolio into the euro and the pound remains. That could exacerbate the downward pressure on the dollar.

From India's perspective, a decline in the dollar against the major currencies invariably means appreciation for the rupee. Indian exporters have to review their strategic options. Diversifying production bases to economies whose currencies are relatively weak and increased billing in the euro or pound are possible alternatives. But then, that's another story.

The author is chief economist, HDFC Bank [Get Quote]. The views here are personal.