Asia’s central banks face a formidable challenge: An ascendant U.S. dollar

Central banks in Asia face a catch-22 in 2025.

A relentless rise in the US dollar has sent Asian currencies such as the Japanese yen, the South Korean won, the Chinese yuan and the Indian rupee sliding to multi-year lows against the greenback.

While a cheaper currency could in principle make exports competitive as President-elect Donald Trump threatens to impose tariffs, central banks in Asia would need to assess its impact on imported inflation and avoid speculative bets on a sustained weakness in their currencies that could complicate politics. , analysts said.

The US dollar has appreciated a lot since Trump won the 2024 presidential election, increasing about 5.39% since the November 5 election in the United States.

Part of the reason for the strength of the US dollar is the policies that Trump had promised on the campaign trail, including tariffs and tax cuts, which are seen by economists for being inflationary.

Federal officials at their December meeting expressed concern about inflation and the impact that President-elect Donald Trump’s policies could have, indicating that they will move more slowly on interest rate cuts because of the uncertainty, the minutes published on Wednesday showed.

The reassessment of the Fed’s monetary policy outlook widened the yield gap between the US and many Asian bonds.

This interest rate differential has dampened the appeal of lower-yielding assets, sending major Asian currencies lower and prompting some central banks including the Bank of Japan and the Reserve Bank of India to intervene

James Ooi, market strategist at online broker Tiger Brokers told CNBC that a strong US dollar would make it harder for Asian central banks to manage their economies.

A stronger US dollar is likely to “pose challenges for Asian central banks by increasing inflationary pressures through higher import costs and straining their [central banks’] foreign exchange reserves if they try to support their currencies through interventions,” Ooi told CNBC by email.

“If a country is faced with high inflation and a depreciating currency, lowering interest rates to stimulate economic growth can be counterproductive,” Ooi added.

China’s onshore yuan hit a 16-month low of 7.3361 on Jan. 7, pressured by rising U.S. Treasury yields and a stronger dollar.

A weaker yuan would apparently make Chinese exports more competitive and hopefully spur growth in Asia’s largest economy.

But Lorraine Tan, director of equity research for Asia at Morningstar, said a stronger US dollar would limit the People’s Bank of China’s ability to lower interest rates without risking a rise in the capital flow, as well as helping the domestic economy to have more monetary flexibility. .

Since then, China has struggled to sustain its economy last Septemberwith several stimulus measures including reductions in interest rates and support for the stock and real estate markets.

More recently, the country expanded its consumer trade scheme aimed at boosting consumption equipment upgrades and subsidies.

“That said, it is the fiscal spending side that needs to pick up to support China’s growth,” Tan added.

This view was echoed by Ken Peng, head of investment strategy for Asia Pacific at Citi Wealth. He said the Chinese government should issue more long-term bonds to finance its economic stimulus, instead of cutting taxes.

“[China] he doesn’t need to do more monetary policy. So it should not be a question PBOC. It should be [a] MOF [ministry of finance] question,” said Peng.

In addition, in the often zero-sum world of export competitiveness, a pronounced weakness in the yuan could make it more complicated for other Asian economies to increase the appeal of their products and services to foreign buyers.

Citi Wealth, in its 2025 outlook report, said that a sharp depreciation of China’s currency could hurt economies that directly compete with or export to China, such as South Korea, Taiwan and others in the Southeast Asia.

The Bank of Japan spent more than 15.32 trillion yen ($97.06 billion) to strengthen the currency in 2024, after the yen fell to multi-decade lows in July, hit a low of 161.96.

Despite this, the currency is at around 158 against the greenback, at its weakest since the lows of July.

Japanese financial officials have repeatedly issued warnings against “unilateral” and “volatile” movements in the yen, most recently on January 7th.

To be sure, a strong dollar can partially play into the goals of the BOJ.

After struggling to deal with deflation for decades, inflation in Japan has exceeded the BOJ’s 2% target for 32 consecutive months. U BOJ recognized that the weakness in the yen could lead to a rise in imported inflation.

The challenge would be to ensure that prices and wages do not rise faster than levels the BOJ is comfortable with.

Tan at Morningstar said the greenback’s strength adds pressure on the BOJ to raise rates to strengthen the yen and mitigate inflation risks.

In South Korea, its central bank recently stepped in to support the won, according to a Jan. 6 Yonhap report. Although the specific amount is not disclosed, it was enough to cause a the country’s foreign reserves fell to a five-year low.

The won has steadily depreciated against the dollar since Trump’s election victory, hitting around 1.476 against the greenback in December, its weakest level since 2009.

The Bank of Korea has appeared as a priority to stimulate domestic growth despite a weakened wind, with the central bank. enactment of a surprise 25 basis point cut in their last meeting in November.

“Although the volatility of the exchange rate has increased … the downward pressure on economic growth has intensified. The Council, therefore, has judged that it is appropriate to further cut the base rate and mitigate downside risks to the economy,” he wrote in his statement. .

All of these measures, however, were overshadowed by uncertainty when President Yoon Suk Yeol declared and then revoked martial law in early December, and was subsequently impeached.

The BOK called an emergency meeting on December 4, and undertakes to provide “a sufficient amount of liquidity” until the financial and exchange markets stabilize. These measures will be in effect until the end of February.

The last among the main Asian currencies is India, which saw the rupee dipped to a record low of 85.86 on January 8, due to pressure from the strong dollar and sold by foreign portfolio investors in October and November.

India is faced with inflation that breached the upper tolerance limit of 6% of the RBI in October, reaching 6.21%, although it is expected to moderate.

This comes at a time when the country’s growth is slowing down, along with India the most recent GDP reading coming in at 5.4% in its second fiscal quarter ending in September, missing expectations and marking its lowest level since the last quarter of 2022.

In his most recent monetary policy meeting in December, the RBI kept rates at 6.5% in a split decision, with two board members voting for a cut of 25 basis points.

If India chooses to cut rates to stimulate growth – which would weaken the rupee – the RBI is well equipped to deal with a potential sudden outflow of foreign funds and any sharp fall in the rupee.

Citi Wealth said in its 2025 outlook report that “large central bank foreign exchange reserves have brought greater stability to the Indian rupee.”

Citi’s Peng also describes the rupee as “one of the most stable currencies in the world”, adding that “the only currencies that are less volatile than the Indian rupee are pegged currencies like the Hong Kong dollar. And so it should be a relief for many foreign investors who may have interest in this market.”