Currency defence gets makeover as emerging Asia guards reserves

Central banks in emerging Asia are increasingly finding ways to support their currencies without dipping into foreign-exchange reserves, as recurring Middle East tensions and the prospect of higher-for-longer US interest rates keep policymakers on edge.

India has lured nearly $40 billion from its diaspora via high-yield dollar deposits, underpinning a recovery in the rupee from a record low in May. South Korea's push to accelerate corporate dollar repatriation has helped the won to its biggest monthly gain since 2022. Indonesia drew $1.6 billion in bond inflows in the last two months as it offered incentives to foreign funds, and Taiwan has also been instructing exporters to sell US dollars at times of currency weakness.

Infograph: TBS

The measures broaden the toolkit for policymakers, supplementing traditional tools such as interest-rate hikes and foreign-exchange intervention that formed the first line of defence after the Mideast conflict sent oil prices soaring. The spike exposed emerging Asia's heavy reliance on energy imports, making the region one of the weakest pockets of the 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.

"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."

Indonesia's 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.

By contrast, Latin American currencies occupy the top of the rankings, led by the Colombian peso, Brazilian real and the Mexican peso. The region offers higher interest rates than most of its developing-nation peers, and many of its countries are oil exporters, making them relatively insulated from the impact of 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 stabilise, 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 including 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."

Meanwhile, in Japan, Asia's biggest developed market, policymakers appear to be leaning more heavily on foreign-exchange intervention. The first joint yen-buying operation from Japan and the US since 1998 recently helped spur one of the currency's most notable rebounds.

To be sure, EM Asia central banks aren't abandoning traditional defences.

Bank Indonesia boosted interest rates by 100 basis points in May and June, and has continued to intervene in the currency market, much like its Indian peer. The two countries, along with the Philippines and Thailand, have witnessed Asia's biggest drawdowns in FX reserves since the start of the Iran war, with declines of 4% to 9%.

Authorities in the Philippines have raised rates by 50 basis points, and the Bank of Korea last month tightened policy for the first time in three years. MUFG Bank Ltd. is forecasting two more increases by Indonesia and the Philippines, and at least one more hike by the BOK this year.

The path of US monetary policy remains key for investors, especially after three Federal Reserve officials dissented from last month's decision to hold rates steady. The dissenters also warned that waiting too long to act against inflation could risk the need for even more aggressive policy moves 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."