Asian Central Banks Increase Currency Defense with Derivatives

Amid a strong dollar, central banks across Asia are augmenting their currency protection strategies by deploying derivatives. This raises questions about the sustainability and potential risks associated with this approach.

Surge in Net Dollar Short Forward Positions

The Reserve Bank of India's net dollar short forward position reached a record high of $68 billion in December, while Bank Indonesia's hit $19.6 billion, its highest since at least 2015. These figures indicate a shift in the defensive tactics employed by central banks.

Concerns and Risks

However, reliance on derivatives raises concerns about deferring selling pressure rather than eliminating it. "It's essentially pushing out currency depreciation and maintaining headline reserves high to display confidence," said Dhiraj Nim, a currency strategist at ANZ.

The RBI and BI have confirmed their use of derivatives but have not immediately responded to requests for comment.

Political Risks and Trump's Influence

Political headwinds, particularly from the US, have intensified pressure on emerging-market central banks. President Trump's tariff threats and scrutiny of currency manipulation have added to the sensitivity surrounding intervention.

Advantages of Forwards and Masking Interventions

Forwards provide central banks with advantages such as lower costs and the ability to keep interventions discreet. They do not drain the money supply or attract the ire of the US government.

Shift in Strategies and Recent Trends

Malaysia has also adopted the use of currency forwards, while the Philippines has reduced its net long forward position. The Reserve Bank of India's new Governor has signaled a more flexible approach to exchange rate management.

Outlook and Risks

Despite a recent decline in the dollar, the advantages of forwards suggest that this strategy will remain popular among central banks. However, excessive forward book accumulation could pose potential risks.