Middle East risks spread, Asia launches "currency defense war": raising interest rates, intervention, iron fist—using every possible measure!

The energy shock triggered by the Middle East war and expectations of Fed rate hikes are combining to transmit pressure across the entire Asian currency market. From Seoul to Jakarta, from Mumbai to Tokyo, central banks and regulators are taking intensive action, employing all available tools including interest rates, foreign exchange intervention, and regulatory inspections, vowing to defend their currency at all costs.

On Wednesday, South Korea launched its first joint on-site inspection of foreign exchange banks in 14 years. Indonesia’s central bank urgently announced a rate hike between routine meetings; Japan’s central bank is expected to complete a rate adjustment this month; India, meanwhile, has introduced a slew of new tax and fiscal policies to attract foreign investment while keeping rates unchanged. The region’s policy toolbox is being emptied at an unprecedented pace.

The root of market pressures lies in the resonance of two forces: The Iran war has driven up global oil prices, directly boosting inflation in Asian countries and widening current account deficits; meanwhile, expectations for the Fed’s forced rate hikes are intensifying, the dollar strengthens and foreign capital withdraws, all adding pressure to Asian currencies.

According to Bloomberg, Wee Khoon Chong, senior market strategist for BNY Asia Pacific, said, "The regional forex market is under multiple pressures from a strong dollar, high oil prices, and capital outflows. Regional central banks and authorities are on high alert."

Dual depreciation logic: Oil shock and Fed rate hike expectations

The Middle East situation is the direct trigger for the current pressure on Asian currencies. After the outbreak of the Iran war, global crude oil prices soared, dealing a double blow to energy-import-dependent Asian economies—on the one hand boosting domestic inflation, and on the other expanding trade deficits, increasing pressure on local currencies to depreciate.

Meanwhile, the uncertainty over the Fed's policy path has amplified market volatility. According to Bloomberg, Dallas Fed President Lorie Logan has explicitly mentioned the possibility of rate hikes, with market expectations for a higher U.S. rate center continuing to strengthen. The strong dollar suppresses Asian currencies and triggers faster foreign capital flight from Asian stock and bond markets.

The Bloomberg Asia Currency Index has fallen for several consecutive days, led by declines in the Korean won and Indonesian rupiah. Against this backdrop, policymakers in each country face a similar dilemma: raising interest rates can stabilize the currency, but would suppress already pressured economic growth; not raising rates may trigger larger capital outflows and a currency depreciation spiral.

South Korea: First FX bank inspection in 14 years, a “red line” drawn

The won fell to its lowest level since 2009 last week, prompting South Korean authorities to escalate their response from verbal warnings to direct actions.

According to Bloomberg, on Wednesday, the Bank of Korea and the Financial Supervisory Service began joint on-site and off-site inspections of major foreign exchange banks—the first time in 14 years. Authorities will check whether relevant institutions have engaged in actions that may disrupt the FX market, and investigate whether participants have tried to manipulate the exchange rate for improper gain. Previously, officials held an emergency meeting on June 7 and announced on Tuesday that speculative FX trading would be cracked down on. The financial regulator also announced that the frequency of checking major banks' FX positions would be temporarily raised from once a month to weekly or even daily.

Choi Jemin, an economist at Hyundai Motor Securities, said, "This is an effort to instill greater caution in a market that previously lacked a clear red line." He noted that as USD/KRW broke above 1500, divergence from fundamentals became increasingly driven by market sentiment. "In this situation, the authorities are essentially the only actors who can curb such expectations." Choi Jemin also said the new measures reduced the likelihood of USD/KRW hitting 1600.

Boosted by these measures, the won rose 0.9% to 1,527 on Wednesday, gaining more than 2% this week. Nevertheless, the won is still down 5.3% this year, ranking among the worst performing Asian currencies, ahead of only the Indonesian rupiah and Indian rupee.

Indonesia: Emergency rate hike hits “panic button”, rupiah falls to historic low

Indonesia faces the most severe situation among Asian countries. The rupiah has fallen nearly 8% this year, the region's worst performing currency, at one point hitting an all-time low of 18,210.30.

On the 9th, Indonesia’s central bank announced a 25 basis point hike in its benchmark rate to 5.50%. This hike happened outside the routine policy meeting and was an emergency action. According to Bloomberg, this unconventional move came just a day after a senior official denied any special arrangements, surprising the market. Indonesia's central bank also announced intensified currency operations in the rupiah and foreign currency markets, plans to raise government bond yields through market mechanisms to attract foreign capital, and enhanced hedging swap tools for foreign investors.

Central bank data showed that Indonesia’s FX reserves in May fell by $1.3 billion to $144.9 billion, not only a nearly two-year low, but also the longest five-month consecutive decline since 2018, raising alarm over the speed of reserve depletion.

Analysts say the rate hike gives the rupiah short-term support, but lasting effects depend on fundamental shifts in government policy direction. Since President Prabowo Subianto took office, policies such as tightening control over commodity exports, restricting conversion of rupiah to dollars, and giving parliament power to scrutinize central bank performance have eroded investor confidence.

Japan: Rate hike expectation confirmed, “behind the curve” central bank catching up

Japan’s policy shift gives another important reference point for this round of Asia's currency defense.

According to Nikkei, the Bank of Japan plans to raise its benchmark rate from 0.75% to 1.0% at the monetary policy meeting on June 15-16, with Governor Kazuo Ueda personally submitting the proposal, which is expected to secure majority support. Meanwhile, the bank intends to stop scaling down government bond purchases after April 2027, retaining flexibility in rate hikes.

Looking ahead, former BOJ executive director Hideo Hayakawa stated, after the June hike, "the next hike could come as soon as October," and plainly said, "The BOJ has already fallen a bit behind the curve and needs to catch up at some point." Hayakawa noted that recent turbulence in Japan’s bond market and worries about fiscal policy direction have complicated the Bank's decision-making, combined with inflation pressures, leaving the BOJ virtually no choice.

If the rate hike goes ahead as scheduled, it will be the BOJ’s first policy rate adjustment since last December and will be a key support for the yen under current pressures.

India: Holds rates, takes alternative route to attract dollar inflows

The Reserve Bank of India last Friday chose a different path from most neighbors—maintaining the benchmark rate, instead using fiscal and tax policies to attract foreign investment to stabilize the rupee.

According to Reuters, the RBI's Monetary Policy Committee unanimously voted to keep the repo rate at 5.25% and maintained a “neutral” policy stance. Governor Sanjay Malhotra said, "Despite elevated upside risks to inflation, the committee believes the prudent course is to wait for further clarity," and the central bank will remain “data dependent.”

Meanwhile, the Indian government announced the removal of capital gains and interest taxes on government bonds held by foreign investors, while the RBI will offer preferential FX swap arrangements for state-owned enterprises and compensate for hedging costs on foreign currency deposits aimed at overseas Indians. Larsen & Toubro Group chief economist Sachchidanand Shukla estimates the measures will attract $40–60 billion in inflows.

The rupee has fallen around 5% this year. RBI raised its inflation forecast for this fiscal year to 5.1%, while GDP growth was lowered to 6.6%. According to Reuters, most economists now expect India to raise rates in the second half of the year. State Street Investment Management Asia Pacific economist Krishna Bhimavarapu said, "The RBI’s revised growth and inflation forecasts and its prudent policy guidance suggest it is laying the groundwork for a possible policy shift as early as August."

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