Asian Currencies Trapped in an Undervaluation Quagmire, Long Road to Normalization Even if Iran War Ends

Oil Price Surge and Stronger Dollar Triggered by Iran War
Simultaneous Pressure Across Asian Foreign Exchange Markets
Limited Currency Defense Despite Rate Hikes and Tax Incentives

The surge in oil prices and strengthening U.S. dollar triggered by the Iran war are rattling Asian foreign exchange markets. Indonesia has deployed interest rate hikes and tighter regulations on offshore non-deliverable forwards (NDFs) to defend the rupiah, but its foreign exchange reserves have retreated to their lowest level in two years. The Korean won is also facing pressure toward the ₩1,500-per-dollar threshold amid slowing growth and capital outflow concerns. Although discussions of a possible end to the conflict have emerged, accumulated inflationary pressures, limited room for monetary tightening, and the lingering effects of the yuan’s undervaluation are combining to make it difficult for major Asian currencies to emerge from their undervalued state anytime soon.

Indonesia’s Foreign Exchange Reserves Depleted, Central Bank Raises Rates for Second Consecutive Month

According to Bloomberg on June 17 (local time), the Indonesian government recently strengthened regulatory barriers in the NDF market, a venue for non-commercial transactions, effectively declaring an all-out battle against speculative capital. Indonesia is currently facing mounting pressure throughout its economic value chain as the rupiah’s defensive line has been breached despite persistent direct intervention by Bank Indonesia (BI) through dollar sales. The country’s heavy dependence on energy imports has been a major factor. The Iran war drove global oil prices sharply higher, and the resulting flight to safe-haven assets boosted demand for the U.S. dollar, causing the rupiah to weaken significantly.

The strain from currency defense efforts first became evident in the nation’s foreign exchange reserves. Indonesia’s foreign currency assets within its reserves declined to $122.8 billion last month, their lowest level in two years. Continued intervention through dollar sales by the central bank has rapidly weakened the country’s foreign exchange buffer, while simultaneously fueling market skepticism regarding its ability to defend the currency.

In response, Bank Indonesia followed its 0.5-percentage-point rate increase in May with another 0.25-percentage-point hike on June 9, raising its policy rate to 5.5%. The emergency move came after the rupiah deviated from its projected path and approached record-low levels, prompting the central bank to accelerate its regular monetary policy schedule. At the same time, authorities signaled preemptive tightening by pledging to keep inflation within the government’s target range of 2.5±1% in 2026 and 2027. The objective is to block the transmission of exchange-rate instability into import prices and inflation expectations at an early stage.

Simultaneously, the central bank raised yields on its short-term securities (SRBI) to attract foreign capital while expanding intervention measures in derivative markets. As a result, the rupiah recovered somewhat from its steep decline that had threatened the 18,000-per-dollar level, stabilizing around 17,600 per dollar. Nevertheless, with shrinking foreign exchange reserves, foreign capital outflows, and weakening policy credibility occurring simultaneously, the rebound appears largely aimed at buying time. Indonesia’s foreign exchange market has already entered an emergency phase requiring the full deployment of interest rates, derivatives, and reserve assets.

Shadow of Low Growth Intensifies Pressure on the Won

According to Bloomberg on June 17 (local time), the Indonesian government recently strengthened regulatory barriers in the NDF market, a venue for non-commercial transactions, effectively declaring an all-out battle against speculative capital. Indonesia is currently facing mounting pressure throughout its economic value chain as the rupiah’s defensive line has been breached despite persistent direct intervention by Bank Indonesia (BI) through dollar sales. The country’s heavy dependence on energy imports has been a major factor. The Iran war drove global oil prices sharply higher, and the resulting flight to safe-haven assets boosted demand for the U.S. dollar, causing the rupiah to weaken significantly.

The strain from currency defense efforts first became evident in the nation’s foreign exchange reserves. Indonesia’s foreign currency assets within its reserves declined to $122.8 billion last month, their lowest level in two years. Continued intervention through dollar sales by the central bank has rapidly weakened the country’s foreign exchange buffer, while simultaneously fueling market skepticism regarding its ability to defend the currency.

In response, Bank Indonesia followed its 0.5-percentage-point rate increase in May with another 0.25-percentage-point hike on June 9, raising its policy rate to 5.5%. The emergency move came after the rupiah deviated from its projected path and approached record-low levels, prompting the central bank to accelerate its regular monetary policy schedule. At the same time, authorities signaled preemptive tightening by pledging to keep inflation within the government’s target range ofSouth Korea, which is likewise heavily dependent on energy imports, faces a similar predicament. Since the outbreak of the Iran war, rising global oil prices and a stronger dollar have placed the won under relatively severe pressure compared with other major Asian currencies. The won-dollar exchange rate has risen to the point where a sustained move into the 1,500 range is being discussed, while the won’s real effective exchange rate—a measure of its actual purchasing power—has fallen to its lowest level since the 2008 global financial crisis. Foreign exchange markets have begun pricing in the possibility of a slowdown in the Korean economy.

The government has also reached a point where it can no longer leave exchange-rate issues entirely to the market. This reality partly explains the recent introduction of measures designed to redirect overseas equity investment funds back into domestic stock markets. Since March 24, the government has implemented a system offering substantial capital gains tax reductions for funds repatriated after the sale of overseas equities and transferred into “Reinvestment into Korea Accounts” (RIA). The measure is intended to achieve two objectives simultaneously: stabilizing the foreign exchange market and revitalizing domestic capital markets.

However, such incentives alone are unlikely to reverse foreign exchange market dynamics. Korean investors’ holdings of overseas equities have already reached record highs. Capital has flowed heavily into major U.S. technology stocks such as Nvidia, Microsoft, and Apple, increasing demand for dollars in the process. As overseas investment has evolved from a temporary trend into a long-term structural shift, the demand base supporting the won has weakened compared with the past. 2.5±1% in 2026 and 2027. The objective is to block the transmission of exchange-rate instability into import prices and inflation expectations at an early stage.

Simultaneously, the central bank raised yields on its short-term securities (SRBI) to attract foreign capital while expanding intervention measures in derivative markets. As a result, the rupiah recovered somewhat from its steep decline that had threatened the 18,000-per-dollar level, stabilizing around 17,600 per dollar. Nevertheless, with shrinking foreign exchange reserves, foreign capital outflows, and weakening policy credibility occurring simultaneously, the rebound appears largely aimed at buying time. Indonesia’s foreign exchange market has already entered an emergency phase requiring the full deployment of interest rates, derivatives, and reserve assets.

Even the current account surplus is failing to function as an effective exchange-rate buffer. Although dollar inflows have increased due to strong semiconductor exports, institutional and retail investors are simultaneously expanding overseas investments. Dollars earned through exports are repeatedly flowing back out into foreign asset markets rather than remaining within Korea’s financial system. As of the first quarter of this year, South Korea’s net financial account assets—including foreign direct investment and portfolio investment—stood at $65.42 billion. The increase reflects rising overseas investments by corporations, retail investors, and public pension funds alike.

Declining potential growth is also amplifying depreciation pressure on the won. Korea’s stronger growth performance this year has been overwhelmingly dependent on the semiconductor supercycle, while the economy’s underlying fundamentals lag behind those of the United States, whose economy is more than ten times larger. In fact, Korea’s potential growth rate has trailed that of the United States since 2023. An additional external factor is the won’s increasing correlation with the Japanese yen. Japan has entered a phase in which yen weakness is becoming structurally entrenched amid prolonged stagnation and rising inflation. As the won increasingly behaves like a proxy for the yen, depreciation pressure originating in Japan is being transmitted directly into the Korean currency.

Inflation Weighs on Asian Currencies

Some market observers argue that Asian currencies cannot recover unless the war ends. However, the end of the conflict is unlikely to translate directly into a currency rebound. The Middle East shock has already spread beyond foreign exchange markets into broader price levels. The Asian Development Bank (ADB) estimates that the Iran war could reduce Asia’s growth rate to 4.2% this year and 4.0% next year while pushing inflation as high as 7.4%. Rising transportation costs, electricity expenses, and raw material prices following the increase in oil prices have expanded production cost burdens across the region.

Even if shipping through the Strait of Hormuz returns to normal, elevated insurance premiums, freight rates, and inventory replenishment costs are already supporting a higher inflation floor. Moreover, the process by which higher energy prices are transmitted into manufacturing, logistics, and consumer goods prices is still underway. Companies have begun passing increased energy costs on to consumers, while households are increasingly treating future inflation as a foregone conclusion. In other words, the price stability that forms the foundation for currency recovery is itself becoming unstable.

Another obstacle to a broad recovery in Asian currencies is interest rates. With inflationary pressure spreading in the aftermath of the conflict, central banks would need to raise policy rates significantly to restore currency values. However, aggressive tightening risks intensifying economic downside pressure at a time when growth is slowing and domestic demand remains weak. Currency defense and economic stabilization are thus on a direct collision course.

The yuan is also delaying currency normalization. China has maintained export competitiveness for years through an undervalued yuan, creating an environment in which manufacturing-oriented Asian currencies struggle to strengthen broadly. Although the yuan has recently shown signs of modest appreciation, the accumulated competitive pressures on manufacturing prices are unlikely to dissipate quickly. Restoring exchange rates to normal levels requires containing inflation and capital outflows, yet stronger currencies simultaneously increase competitive pressure from low-cost Chinese exports. The weakness of Asian currencies is therefore being driven by a combination of war-related shocks, inflation, interest-rate constraints, and manufacturing competitiveness concerns. Even if the conflict ends, the lingering effects of the oil price shock, elevated inflation expectations, and offshore derivatives positioning are likely to continue unsettling Asian foreign exchange markets for some time.