Central banks across Asia, including the Reserve Bank of India (RBI) and Bank Indonesia (BI), are increasingly relying on currency derivatives, specifically dollar forwards, to protect their currencies against the strengthening US dollar. The net dollar short forward positions at the RBI hit a record $68 billion in December, while BI’s reached $19.6 billion, the highest since 2015. This surge in forward positions reflects a shift in strategy to manage currency pressure without directly depleting foreign reserves. However, it raises concerns about the long-term sustainability of this approach.
Deferred Pressure vs. Immediate Action
The use of dollar forwards allows central banks to delay the impact of currency depreciation by agreeing to sell dollars at a later date for a pre-set price. This approach helps maintain headline reserves and gives the appearance of stability, but it may only be pushing the problem of depreciation into the future. Experts worry that while this strategy may appear effective in the short term, it risks accumulating pressure that will need to be dealt with later, potentially in larger amounts.
Dhiraj Nim, a currency strategist at Australia and New Zealand Banking Group, expressed concerns that this tactic could be creating an illusion of stability. “It’s basically pushing out currency depreciation to a later date and in the meantime, keeping headline reserves high as a way of displaying confidence,” Nim said.
Political and Market Pressures
The rise in currency intervention through derivatives comes amid significant political pressure, particularly from the United States. Under President Donald Trump, the US has aggressively scrutinized currency manipulation, especially regarding emerging-market countries. Trump’s administration has been known to label countries like China as currency manipulators, and India has been on the US watchlist in the past. As a result, central banks may be using dollar forwards to avoid direct intervention that could draw attention from the US and avoid being accused of manipulating their currencies.
Advantages and Risks of Dollar Forwards
Dollar forwards offer certain advantages for central banks. They don’t directly drain the money supply or reserves, and their use allows central banks to mask their intervention strategies. By using these derivatives, central banks can also avoid triggering concerns in the market about excessive intervention. This is why several countries, including Malaysia and the Philippines, have also turned to forwards to manage currency pressures.
However, the strategy comes with risks. Although dollar forwards don’t immediately deplete reserves, they may create a buildup of future obligations that could lead to larger interventions down the line. The risk is particularly acute if a country has a significant short forward position and faces unexpected financial pressures.
Current Situation: The Dollar Declines, but Risks Remain
A recent decline in the US dollar has provided some relief for central banks, with a broad gauge of the dollar falling more than 1.6% so far this year. US President Trump’s delay of tariffs on countries like Canada, Colombia, and Mexico has also softened the immediate impact of the dollar’s strength. These developments have raised hopes that the need for such interventions may decrease in the near term.
Still, despite the softer dollar and some potential shifts in central bank strategy, including RBI Governor Sanjay Malhotra’s flexible approach, the use of dollar forwards remains popular. Central banks may continue using them as long as they offer advantages in terms of cost-effectiveness and flexibility. However, policymakers will need to carefully monitor the growing size of their forward books to avoid potential future vulnerabilities.
In conclusion, while dollar forwards may provide a temporary shield for central banks from currency volatility, they also raise questions about the long-term risks of deferring pressure rather than addressing it. With emerging-market currencies, such as the Indian rupee and Indonesian rupiah, under continued strain, this strategy could lead to challenges down the road.
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