A SURPRISE interest-rate cut in Indonesia and signs the Reserve Bank of India may be willing to loosen its tight grip on the rupee may be an indication that central banks’ defence against a strong US dollar is cracking.
Asian central banks have been shielding their currencies through interventions in the face of the greenback’s relentless rally fuelled by bets that US president-elect Donald Trump’s low-tax, high-tariff policies will fuel inflation. However, that approach is shrinking the foreign-exchange stockpile of some of these nations, with persistently sluggish growth forcing some central banks to prioritise boosting their economies over currency management.
“I reckon Asian central banks will throw in the towel soon on the aggressive defence of their currencies if Trump moves ahead with tariffs in a strong US dollar regime,” said Alex Loo, macro strategist at TD Securities. “Asian central banks are likely paying more attention to their drawdown of their FX reserves and if trade starts to slow globally, that implies less US dollars to add to their reserves.”
Large foreign-currency reserves with Asian central banks were instrumental in safeguarding the region’s currencies. However, India’s forex reserves have slid US$70 billion since hitting a record high of US$705 billion as at the end of September while Korea’s pile dropped over US$50 billion over two years.
Meanwhile, the US dollar continues to be resilient and uncertainties surrounding Trump’s policies ahead of his inauguration next week are providing little comfort for Asia’s currency traders as they have made interest-rate decisions increasingly difficult to predict.
The Bank of Korea held rates steady on Thursday (Jan 16), belying expectations of a third consecutive cut, saying it was a tough call to shore up a currency battered by political turmoil. The Indonesian central bank on the other hand surprised with a rate cut on Wednesday to bolster the economy even as the move pummelled the currency.
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“The surprising rate decisions underscored heightening uncertainties over the emerging Asia rate and currency outlook,” said Ken Cheung, strategist at Mizuho Bank in Singapore. “It seems Asian central banks are struggling to achieve the targets of FX stability and supporting growth simultaneously ahead of tariffs threats.”
Central banks in Japan and Singapore are also expected to deliver their policy decisions this month.
Uncertain policy
Currency traders are bracing for these uncertainties. Most emerging Asian currencies have weakened against the US dollar so far this month, with the Indonesian rupiah underperforming the group. Traders are also watching currency policies in India and China – the region’s two biggest economies – to assess their impact on the region.
The People’s Bank of China has so far maintained a tight hold on its currency through its daily reference rate that caps the yuan’s move by 2 per cent on either side. It also sold yuan bills in Hong Kong to shrink liquidity offshore and cap the currency’s losses. However, analysts say China may eventually let the yuan weaken to blunt the impact of potential US tariffs on the nation’s exports and make room for more monetary easing to revive the economy.
The Reserve Bank of India’s next rate decision in February is becoming a focal point for rupee traders as it would be the first one under governor Sanjay Malhotra. QuantEco Research has pushed back its rate cut call to April, citing pressures on the currency while IDFC FIRST Bank expects next month’s decision to be a coin toss.
People familiar with the Malhotra’s thinking have said he has shown a willingness to allow the rupee to move more freely in tandem with peers. That suggests a departure from his predecessor’s approach of keeping a tight rein on the currency.
Apart from interest rates, analysts expect central banks to deploy a range of tools to manage their currencies. Korea’s National Pension Service will be activating its FX hedging soon, according to Nomura Holdings. For Indonesia, the rule mandating export proceeds to be retained onshore could be revised soon to widen duration and coverage, according to Bank of America.
Still, it’s unclear how effective central banks will be in shielding their currencies from the rising tide of the US dollar.
“Policy responses are diverging in the region, as central banks weigh domestic priorities vis-a-vis volatility in their currency and bond markets due to global triggers,” said Radhika Rao, senior economist at DBS Bank in Singapore. “Authorities are likely to show their hand to limit sharp swings but not turn the tide.” BLOOMBERG
