Asia's Central Banks Forge New Currency Defense Tools as Geopolitical Risks Mount

Central banks across emerging Asia are increasingly relying on innovative capital-flow strategies to support their currencies without depleting foreign-exchange reserves, as recurring Middle East tensions and expectations of prolonged elevated US interest rates keep policymakers under pressure.

The measures broaden the policy toolkit beyond traditional interest-rate hikes and direct foreign-exchange intervention, which formed the first line of defense after the latest Mideast conflict sent oil prices soaring. That spike exposed emerging Asia's heavy reliance on energy imports, making the region one of the weakest pockets of the global currency market. While oil prices have since eased on signs the US and Iran are nearing a deal, several Asian currencies still rank among this year's worst performers.

**Country-by-Country Approaches**

India has lured nearly $40 billion from its overseas diaspora through high-yield dollar deposits, helping to underpin a recovery in the rupee from a record low in May. South Korea's push to accelerate corporate dollar repatriation has contributed to the won's biggest monthly gain since 2022. Indonesia drew $1.6 billion in bond inflows over the past two months by offering incentives to foreign funds, while Taiwan has instructed exporters to sell US dollars at times of currency weakness.

"There are a variety of motivating factors, but they essentially come down to preserving FX reserves as best as possible amid structurally higher volatility and uncertainty," said Claudio Piron, head of Asia FX and rates strategy at BofA Global Research. "Additionally, they are trying to balance the needs of protecting FX stability, while maintaining domestic liquidity. Attracting inflows is a key strategy to achieve this goal."

**Performance and Regional Contrasts**

The Indonesian rupiah, the Indian rupee, and Thailand's baht rank among the five worst performers this year in a basket of 22 emerging-market currencies tracked by Bloomberg. In contrast, Latin American currencies occupy the top of the rankings, led by the Colombian peso, the Brazilian real, and the Mexican peso. That region offers higher interest rates than most emerging-market peers, and many of its countries are oil exporters, giving them relative insulation from higher oil prices.

"On a total-return basis, Latin American currencies may retain an advantage" because of their higher carry, said Desmond Fu, head of investment management at Western Asset Management in Singapore. "On a spot basis, however, selected Asian currencies could close part of the gap if US yields stabilize, energy-market disruption doesn't intensify and the AI investment cycle continues to support technology exports and regional capital expenditures."

Several other analysts, including those at Alpine Macro, State Street Investment Management, and M&G Investments, say the extent of weakness in Asian currencies has been surprising given a mix of positives: trade surpluses, solid macroeconomic fundamentals, robust exports, and buoyant equity markets across the region.

"This suggests that the imbalance lies more in the composition of capital flows than in trade fundamentals, meaning FX intervention alone may not be sufficient to address currency weakness," said Low Guan Yi, head of Asia fixed income at M&G. "Against this backdrop, we expect policymakers to continue broadening the sources of foreign currency inflows."

**Traditional Tools Still in Use**

Emerging Asia's central banks are not abandoning conventional defenses. Bank Indonesia boosted interest rates by 100 basis points in May and June and has continued intervening in currency markets, much like its Indian counterpart. India, Indonesia, the Philippines, and Thailand have recorded Asia's biggest drawdowns in FX reserves since the start of the Iran conflict, with declines of 4% to 9%. The Philippines has raised rates by 50 basis points, while the Bank of Korea tightened policy for the first time in three years last month. MUFG Bank Ltd. forecasts two more rate increases by Indonesia and the Philippines and at least one more hike by the Bank of Korea this year.

In Japan, Asia's largest developed market, policymakers have leaned more heavily on direct intervention. The first joint yen-buying operation with the United States since 1998 recently helped trigger one of the yen’s most notable rebounds.

**Outlook and US Policy Sensitivity**

The path of US monetary policy remains a key variable. Three Federal Reserve officials dissented from last month's decision to hold rates steady, warning that waiting too long to act against inflation could necessitate even more aggressive tightening later.

"Asian central banks are keeping more firepower given the greater uncertainty around global events including how oil prices, El Nino, US yields and the dollar may eventually pan out," said Michael Wan, a senior currency analyst at MUFG Bank in Singapore. "Attracting more dollars will be one prong of the strategy."