A surprise interest rate cut in Indonesia and signals that the Reserve Bank of India (RBI) is easing its control over the rupee suggest that the defense strategies of central banks against the strong U.S. dollar may be faltering.
For months, Asian central banks have intervened to protect their currencies from the dollar’s persistent rise, driven by expectations that U.S. President-elect Donald Trump’s tax cuts and high tariffs will spur inflation. However, this strategy is depleting foreign exchange reserves, with sluggish economic growth prompting some central banks to prioritize boosting their economies over maintaining currency stability.
Alex Loo, macro strategist at TD Securities, remarked, “I reckon Asian central banks will throw in the towel soon on aggressive defense of their currencies if Trump moves ahead with tariffs in a strong dollar regime.” He added that central banks are now more focused on the depletion of their foreign exchange reserves, particularly if global trade begins to slow, resulting in fewer dollars to replenish reserves.
Large foreign currency reserves had historically been a key tool for Asian central banks to safeguard their currencies. However, India’s foreign exchange reserves have fallen by $70 billion since peaking at $705 billion at the end of September. Meanwhile, Korea has seen a $50 billion drop over two years.
Despite these efforts, the dollar remains strong, and the uncertainty surrounding Trump’s policies ahead of his inauguration is making it increasingly difficult for currency traders to predict future rate decisions.
On Thursday, the Bank of Korea held interest rates steady, contrary to expectations of a third consecutive cut, citing the challenge of supporting a currency weakened by political instability. In contrast, Indonesia’s central bank surprised markets with a rate cut on Wednesday, seeking to bolster the economy even as it weakened the rupiah.
Ken Cheung, strategist at Mizuho Bank in Singapore, noted, “The surprising rate decisions underscored heightening uncertainties over the emerging Asia rate and currency outlook,” adding that central banks in the region are struggling to balance currency stability with growth concerns as threats of tariffs loom.
Currency traders are closely watching the decisions of central banks in Japan and Singapore, both of which are expected to make policy announcements this month. So far, most emerging Asian currencies have weakened against the dollar, with the Indonesian rupiah performing the worst. Traders are also monitoring currency policies in China and India to gauge their potential impact on the region’s economies.
China’s central bank, the People’s Bank of China (PBOC), has maintained tight control over the yuan, using its daily reference rate to cap fluctuations within 2%. The PBOC has also sold yuan-denominated bills in Hong Kong to reduce offshore liquidity and limit the currency’s depreciation. However, analysts believe that China may eventually allow the yuan to weaken to counter the potential impact of U.S. tariffs on Chinese exports, while also easing monetary policy to support economic recovery.
In India, the RBI’s upcoming rate decision in February is a critical focal point for rupee traders. This decision will mark the first under new Governor Sanjay Malhotra. Analysts at QuantEco Research have delayed their rate cut predictions until April, citing currency pressures, while IDFC FIRST Bank views next month’s decision as uncertain. Sources close to Malhotra suggest he may be open to allowing the rupee to fluctuate more freely, signaling a shift away from the previous governor’s more restrictive approach.
BofA Securities expects Asian currencies to depreciate in the first half of the year as central banks shift focus to rate cuts to stimulate growth rather than maintain strict currency stability. Claudio Piron, co-head of FX and rates strategy at BofA, stated, “Central banks will pivot to rate cuts as they prioritize supporting growth, rather than over-emphasize a need for FX stability.”
Apart from rate cuts, analysts anticipate that central banks will adopt various strategies to manage their currencies. Korea’s National Pension Service, for example, is expected to activate foreign exchange hedging soon. In Indonesia, the government may revise a rule requiring export proceeds to be retained onshore, potentially extending its coverage and duration.
Despite these measures, the effectiveness of central banks’ interventions in shielding their currencies from the strengthening dollar remains uncertain. Radhika Rao, senior economist at DBS Bank in Singapore, noted, “Policy responses are diverging in the region, as central banks weigh domestic priorities vis-à-vis volatility in their currency and bond markets due to global triggers.” She added that authorities are likely to intervene to limit sharp swings but may not be able to reverse the trend.
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