Asian Central Banks Turn To Derivatives To Defend Currencies

Central banks across Asia are increasingly relying on derivatives to shield their currencies from the surging U.S. dollar, raising concerns about the long-term sustainability of this strategy and the potential risks it may create for the future.

In December, the Reserve Bank of India (RBI) reported a record-high net dollar short forward position of $68 billion, marking an unprecedented level of future dollar sales at pre-set prices. Similarly, Bank Indonesia (BI) reached a net short position of $19.6 billion—the highest since at least 2015, according to the latest official data. These growing forward positions reflect a strategic shift as central banks step up efforts to protect their currencies against dollar strength.

However, the use of derivatives, in conjunction with traditional spot market interventions, has raised concerns among analysts. The risk is that this strategy merely postpones the impact of currency depreciation, rather than eliminating it. “It’s essentially deferring currency depreciation to a later date while maintaining headline reserves, which may project confidence in the short term,” said Dhiraj Nim, a currency strategist at the Australia and New Zealand Banking Group. “I’m worried about the long-term implications of this approach.”

Both the RBI and BI have confirmed their use of derivatives in the past, but neither institution responded immediately to request for comment.

Over the past year, the Indian rupee and the Indonesian rupiah have emerged as two of Asia’s worst-performing currencies, each losing over 3.5% of their value against the dollar.

Political Pressures Add to Complexity

The growing reliance on derivatives comes amid rising political pressures, particularly from the U.S. Under President Donald Trump’s administration, threats of tariffs and accusations of currency manipulation have intensified scrutiny on emerging market central banks. “There’s heightened sensitivity now, especially with the U.S. taking a strong stance on fair trade and currency manipulation,” noted Claudio Piron, co-head of currency and rates strategy at Bank of America Corp. “Central banks are cautious about excessive intervention.”

The U.S. administration’s concerns over currency manipulation became evident following Trump’s inauguration in January 2020, when a fact sheet outlined plans to address the issue. Although currency manipulation designations do not carry immediate penalties, they can create volatility in global financial markets. Trump labeled China as a currency manipulator during his first term, and India has been placed on the U.S. watchlist in the past.

Derivatives like forwards offer several advantages to central banks, including lower costs and the ability to avoid draining foreign reserves. They also help central banks obscure their interventions, which could potentially reduce the political risks of attracting U.S. criticism. These strategies allow central banks to maintain a level of ambiguity, keeping traders uncertain about their next move.

Other countries, such as Malaysia, have also adopted the strategy of using currency forwards. By November 2020, Malaysia’s net short forward book had reached approximately $27.5 billion, an increase of about $4 billion from the previous year. In contrast, the Philippines reduced its net long forward position to just $874 million, according to IMF data.

Bank Negara Malaysia, the country’s central bank, confirmed that it employs foreign exchange swaps and reverse repos to manage onshore liquidity, while the Philippine central bank did not immediately respond to comment requests.

Rupee Gains Following Heavy Intervention

On February 11, the Reserve Bank of India was suspected of conducting a substantial intervention in both the spot and forward markets, resulting in the rupee’s largest gain since November 2022—a nearly 1% rise. Traders reported that the central bank’s actions triggered stop-losses among traders betting against the rupee.

A Declining Dollar Offers Temporary Relief

A recent decline in the dollar has provided some relief for central banks. The U.S. has delayed or canceled tariffs on several countries, including Canada, Colombia, and Mexico, sparking speculation that President Trump may back away from his harshest trade threats. So far this year, a broad gauge of the dollar has fallen by approximately 1.7%.

Furthermore, there are signs that central banks are adjusting their strategies. India’s new central bank governor, Sanjay Malhotra, appears to be adopting a more flexible approach to managing the exchange rate. The RBI has reduced its reliance on non-deliverable forwards and is now focusing on domestic operations to boost liquidity.

Despite these shifts, the advantages of using derivatives ensure that this strategy will likely remain a popular tool for central banks.

“I don’t see many downsides to using the forward market,” said Aaron Hurd, a senior portfolio manager at State Street Global Advisors. While he cautioned that central banks must be mindful of not amassing excessively large forward positions, he does not believe it to be a major concern at present.