TOKYO – India and Indonesia are not often at the center of global financial growth. But as the rupiah and rupee drag Asian currencies lower and lower, events in Mumbai and Jakarta speak to the ways the war in Iran is endangering economies everywhere – and at an accelerating rate.
In the two months since the first bombs fell on TehranAsian governments have raced to cushion financial systems from energy supply shocks. They have curbed fuel use, increased subsidies, made the biggest work-from-home pivot since the Covid-19 crisis and sent diplomats to secure other sources of oil.
However, as the conflict enters its third month and oil trades above $120 a barrel, the rupiah, rupiah and the currencies of countries with chronic fiscal and current account deficits are already out of luck. 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’s 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 decline may accelerate if the RBI cannot stem the flight of foreign funds.
Topping the RBI’s 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 $100 million at the end of each trading day. This means Indian banks will have to cut dollar holdings.
Governor Sanjay Malhotra’s team is tapping RBI’s massive foreign exchange reserves – which came out on top 700 billion dollars at the end of April – to support the rupee in the spot and forward markets.
RBI is tightening regulations on so-called non-delivered transfers (NDFs). Effectively, it bars banks from offering linked derivative contracts to clients, limiting investors’ freedom to bet against the rupee in overseas markets.
RBI is also getting granular. It curbed the rebooking of previous foreign exchange contracts. This alone could force the mitigation of up to $50 billion in arbitrage trades.
In Jakarta, Bank Indonesia is stepping up efforts to protect the rupiah. BI Governor Perry Warjiyo’s team is trying to tighten monetary policy, engage in aggressive market interventions and limit foreign exchange management.
Clearly, the rupiah’s return to the 17,000 level against the US dollar for the first time since the 1997-98 Asian financial crisis is its own warning sign.
Downward pressure comes from the strength of the US dollar, capital outflows, rising energy costs and renewed concerns about fiscal sustainability. The latest risk is that foreign investors are selling Indonesian government bonds.
As Warjiyo said on April 22:Bank of Indonesia is prepared to implement further monetary policy tightening as necessary 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 war in the Middle East lasts. “If the Iran war ends quickly,” says Jason Tuvey at Capital Economics, “we think there’s a good chance the BI will lean towards cutting rates by the end of the year.”
However, that “if” is getting bigger by the day. In the meantime, currency traders are estimating a chance of around 33% that the rupee will weaken 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 deflationary pressures,” says Lloyd Chan, a strategist at MUFG Bank.
Risks from a stalled ceasefire, a dual blockade on the Strait of Hormuz and rising inflation mean “Asian currencies are far from risk-free – and a collapse of the ceasefire could trigger a recessionary spiral,” Ashwin Binwani, founder of Alpha Binwani Capital, told Bloomberg. “The structural reality is brutal for most Asian currencies.”
Binwani thinks the rupee and peso are “the most vulnerable” as the war continues to drive up commodity prices.
Not that you’re weak isn’t grabbing the headlines. of yen rose 3% on Thursday, the most in a day in more than three years, amid reports that 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 come, her strongest signal yet of possible intervention to support the falling yen. Me yen that flirts with psychological significance Level 160it is not clear if it will work.
“Past intervention has only had a temporary effect on the yen unless fundamentals have shifted,” says Kristina Clifton, senior currency strategist at Commonwealth Bank of Australia. “Continued yen depreciation could prompt several rounds of interventions, which in turn would cause larger two-way swings” in the dollar-yen exchange rate.
All this means “the main region to watch is Asia, where dependence on physical energy supplies from the Middle East is higher,” notes Elliot Hentov, a strategist at State Street Investment Management.
Hentov explains that early signs of inflation transmission are now emerging, with the Philippines the first emerging market central bank to tighten policy.
Further rate hikes in emerging markets appear likely, although there are remains a case for central banks to see through short-term inflation to the eventual slowdown in growth – and accompanying disinflationary forces – and wait. “It is at this point that scenario outcomes and policy responses change most materially,” he says.
In the end, notes Hentov, “a re-escalation of the war is still possible, but the main risk is a protracted diplomatic process where energy flows remain blocked. The risk assets globally do not appear to be weighed against the probabilities of sustained disruption and increased economic costs in energy-sensitive regions and sectors.”
A big question is what happens to the dollar. In 1997, a multi-year rally in the dollar made it impossible to maintain Asia’s currency links.
First, Thailand devalued the then-pegged baht. Indonesia next. then South Korea. All three went hand in hand for the International Monetary Fund and other agencies for giant bailouts total 118 billion dollars. The unrest also pushed Malaysia and the Philippines to the brink.
Since then, emerging markets have been highly sensitive to the specter of Fed rate hikes. Case in point: the 2013 Fed “faint tantrum.”
Market concerns over the mere suggestion that the Fed might tighten led Morgan Stanley to release a “fragile five” list that no emerging economy wanted to be on. Original group: Brazil, India, Indonesia, South Africa and Turkey.
Now, a rising dollar is again complicating Asia’s development plans. History’s greatest magnet is luring capital from every corner of the globe, amassing the liquidity needed to finance budget deficits, hold bond yields steady and prop up capital markets.
The Iran war has caused the dollar’s destructive tendencies to burst onto the scene again. Despite the fact that the US national debt is approaching 40 trillion dollarshigh inflation and US President Donald Trump’s tariffs, tax cuts and lavish spending, the dollar is rising – against all odds and economic fundamentals.
Despite the chaos of Trump’s policies, 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 U.S. capital markets are easier to trade in and out of than any other; and because the Federal Reserve’s ability to act as a lender and provider of last-resort liquidity is unsurpassed.
But, adds Lubin, “global trust in the US appears to be eroding, both before and during this year’s war against 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 about the relative insulation of the US economy from the crisis.”
The quick answer is no, “but it would be a mistake to conclude that all is well, for two reasons,” says Lubin. “In the first place, the performance of US asset prices may say less about the status of the dollar than about the relative insulation of the US economy from the crisis. China’s capital markets are coming out of the current crisis very well indeed, which may give Washington pause for thought.”
The same goes for the growing drama at the Fed. In mid-May, Trump will get his long-stated desire to replace Jerome Powell as Fed chairman.
Although Trump 1.0 appointed Powell to the post in 2018, the two men have been at odds during the Trump 2.0 era. However, as Trump’s pick to replace Powell takes over, Kevin Warsh will be under extreme pressure to cut rates — and quickly.
Warsh, however, is likely to face a strong backlash from Fed board members — including Powell, who is staying on as governor — with inflation on the rise. In March, the personal consumption expenditures price index, the Fed’s preferred inflation barometer, rose to one Rate 3.5%. year after year.
“Warsh would be a more desperate voice” who would “lobby for an aggressive reduction in the size of the Fed’s balance sheet and try to make significant changes to the Fed’s communications strategy,” says economist Nancy Vanden Houten at Oxford Economics.
“The Fed chairman cannot make such changes unilaterally, however, and we expect that the need for Warsh to build consensus would limit the scope of changes in policy or the way the Fed communicates.”
Asia will be at the forefront of this clash between Fed doves and hawks. However, it is already there when it comes to the fallout from the US-Israel war in Iran. Asian currencies are flashing red warning signs for the global economy, which could spell disaster if the war in Iran reignites and fuel flows remain blocked for much longer.
Follow William Pesek on X at @WilliamPesek
