TOKYO – India and Indonesia aren’t often at the center of the global financial zeitgeist. But as the rupee and rupiah lead Asian currencies down and down, events in Mumbai and Jakarta speak to the ways the Iran war is imperiling economies everywhere – and at an accelerating rate.
In the two months since bombs first fell on Tehran, Asian governments have been racing to sandbag financial systems from energy supply shocks. They’ve restricted fuel use, amped up subsidies, made the biggest work-from-home pivot since the Covid-19 crisis and dispatched diplomats to secure other oil sources.
Yet as the conflict stretches into a third month and oil trades above $120 per barrel, the rupee, rupiah and currencies of nations with chronic fiscal and current-account deficits are already short of options. And a sense of panic is setting in as the giant game of chicken between the US and Iran plays out.
At the Reserve Bank of India headquarters in Mumbai, officials are trying to put a floor under the exchange rate. This week, the rupee fell to another record low — this time hitting 95.34 to the US dollar. The drop could accelerate if the RBI can’t stop foreign funds from fleeing.
Topping the RBI to-do list is curbing excessive volatility and taming speculative bets. The RBI, for example, has told banks to limit their foreign currency exposure to a maximum of US$100 million at the end of each trading day. It means Indian banks will have to cut dollar holdings.
Governor Sanjay Malhotra’s team is tapping the RBI’s massive foreign exchange reserves — which topped $700 billion in late April — to support the rupee in the spot and forward markets.
The RBI is tightening regulations on so-called non-deliverable forwards (NDFs). Effectively, it stops banks from offering related derivative contracts to clients, limiting investors’ latitude to bet against the rupee in overseas markets.
The RBI is getting granular as well. It slapped curbs on rebooking previous foreign exchange contracts. This alone could force the unwinding of as much as $50 billion in arbitrage trades.
In Jakarta, Bank Indonesia is stepping up efforts to defend the rupiah. BI Governor Perry Warjiyo’s team is scrambling to tighten monetary policy, engage in aggressive market intervention and restrict foreign exchange management.
Clearly, the rupiah being back at the 17,000 level versus the US dollar for the first time since the 1997-98 Asian financial crisis is its own warning sign.
The downward pressure is coming from US dollar strength, capital outflows, rising energy costs and renewed worries about fiscal sustainability. The latest risk is that foreign investors are selling Indonesian government bonds.
As Warjiyo said on April 22: “Bank Indonesia is prepared to implement a further strengthening of monetary policy as needed to maintain the stability of the rupiah exchange rate and keep inflation in 2026 and 2027 within the target range.”
Much depends on how long the Middle East war drags on. “If the Iran war ends soon,” says Jason Tuvey at Capital Economics, “we think there’s a good chance that BI will lean towards cutting rates towards the end of the year.”
Yet that “if” is getting bigger by the day. In the interim, currency traders are pricing in around a 33% chance that the rupiah weakens to 18,000 over the next three months. Bets on a weaker Philippine peso are also taking on a life of their own.
Clearly, “more credible signs of de-escalation are needed to ease depreciation pressures,” says Lloyd Chan, a strategist at MUFG Bank.
Risks from the stalled ceasefire, a dual blockade on the Strait of Hormuz and surging inflation mean “Asian currencies are far from out of danger — and a ceasefire collapse could trigger a recessionary spiral,” Ashwin Binwani, founder of Alpha Binwani Capital, tells Bloomberg. “The structural reality is brutal for most Asian currencies.”
Binwani thinks the rupiah and peso are the “most vulnerable” as the war continues to drive commodity prices higher.
Not that the weak yen isn’t grabbing headlines. The yen surged by as much as 3% on Thursday, the most in a day in over three years, amid reports Tokyo intervened for the first time since 2024 to stabilize the falling currency.
Japanese Finance Minister Satsuki Katayama said the time to take “decisive action” had arrived, her strongest signal yet of potential intervention to prop up the sagging yen. With the yen flirting with the psychologically important 160 level, it’s not clear if it’ll work.
“Past intervention has had only a temporary effect on the yen if the underlying fundamentals haven’t shifted,” says Kristina Clifton, senior currency strategist at Commonwealth Bank of Australia. “Continued yen depreciation may prompt several rounds of intervention, which in turn would cause larger two-way swings” in the dollar-yen rate.
All this means “the key region to watch is Asia, where dependence on physical energy deliveries from the Middle East is highest,” notes Elliot Hentov, a strategist at State Street Investment Management.
Hentov explains that early signs of inflation pass-through are now emerging, with the Philippines the first emerging-market central bank to tighten policy.
Further rate hikes across the emerging markets appear likely, though there remains a case for central banks to look through near-term inflation toward the eventual growth slowdown—and accompanying disinflationary forces — and stay on hold. “It is at this juncture that scenario outcomes and policy responses diverge most materially,” he says.
The bottom line, Hentov notes, “re-escalation of war is still possible, but the core risk is an elongated diplomatic process where energy flows remain blocked. Risk assets globally do not seem priced according to the probabilities of sustained disruption and mounting economic costs in energy-sensitive regions and sectors.”
A big question is what happens with the dollar. In 1997, a multi-year dollar rally made Asia’s currency pegs impossible to maintain.
First, Thailand devalued the then-pegged baht. Next Indonesia. Then South Korea. All three went hat in hand to the International Monetary Fund and other agencies for giant bailouts totaling $118 billion. The turmoil also pushed Malaysia and the Philippines to the brink.
Since then, emerging markets have been very sensitive to the specter of the Fed hiking rates. Case in point: the 2013 Fed “taper tantrum.”
Market jitters over mere hints that the Fed might be hitting the brakes prompted Morgan Stanley to publish a “fragile five” list that no emerging economy wanted to be on. The original group: Brazil, India, Indonesia, South Africa and Turkey.
Now, a surging dollar is complicating Asia’s development plans anew. History’s greatest magnet is luring capital from every corner of the globe, hogging liquidity needed to finance budget deficits, keep bond yields stable and support equity markets.
The Iran war has the dollar’s wrecking-ball tendencies bursting back onto the scene. Despite the US national debt nearing $40 trillion, high inflation and US President Donald Trump’s tariffs, tax cuts and profligate spending, the dollar is rising — against all odds and economic fundamentals.
Despite Trump’s policy chaos, the US bond market is still acting as a safe haven, says David Lubin, an economist at Chatham House.
“As anxiety levels rise during a crisis, institutional investors and governments flock to dollar-denominated assets because US capital markets are easier to trade in and out of than any others; and because the ability of the Federal Reserve to act as lender and liquidity-provider of last resort is second to none.”
But, Lubin adds, “global trust in the US seems to be eroding, both before and during this year’s war on Iran.”
So, he notes, “it’s worth asking whether the dollar’s safe-haven status is showing any signs of ill-health. The performance of US asset prices may say less about the dollar’s status than it does about the relative insulation of the US economy from the crisis.”
The quick answer is no, “but it would be wrong to conclude that all is well, for two reasons,” Lubin says. “In the first place, the performance of US asset prices may say less about the dollar’s status than it does about the relative insulation of the US economy from the crisis. And second, China’s capital markets are emerging really very well from the current crisis, which might give Washington some pause for thought.”
The same goes for the intensifying drama at the Fed. In mid-May, Trump will get his long-stated wish to replace Jerome Powell as Fed chair.
Though Trump 1.0 named Powell to the job in 2018, the two men have been at loggerheads during the Trump 2.0 era. Yet as Trump’s pick to replace Powell takes the helm, Kevin Warsh will be under extreme pressure to cut rates – and fast.
Warsh, though, is sure to encounter strong pushback from Fed board members – including Powell, who’s staying on as a governor – with inflation heating up. In March, the personal consumption expenditures price index, the Fed’s preferred inflation barometer, increased at a 3.5% rate year-on-year.
“Warsh would be a more dovish voice” who “would lobby for an aggressive reduction in the size of the Fed’s balance sheet, and would attempt to make significant changes to the Fed’s communication strategy, says economist Nancy Vanden Houten at Oxford Economics.
“TheFed chair can’t make such changes unilaterally, however, and we expect the need for Warsh to build consensus would limit the extent of changes in policy or how the Fed communicates.”
Asia will be on the frontlines of this standoff between Fed doves and hawks. Yet it’s already there when it comes to fallout from the US-Israeli war in Iran. Asia’s currencies are flashing red warning signs for the global economy, which could presage disaster if the war in Iran reignites and fuel flows remain blocked for much longer.
Follow William Pesek on X at @WilliamPesek
