Bank Indonesia’s new mandate faces first market test after rate hike
It has pushed back against concerns that supporting growth could dilute its commitment to stability
[JAKARTA] Bank Indonesia’s (BI) surprise rate hike is emerging as an early test of whether the central bank can reassure investors that its independence remains intact, after lawmakers expanded its mandate to support economic growth.
While the latest rate increase – announced on Tuesday (Jun 9) – suggests that BI remains focused on defending the rupiah and preserving stability, economists said the bigger question is what happens when those objectives come into conflict with growth.
Harry Baskoro, an economist and former senior deputy director at BI, said markets generally expect the central bank to prioritise monetary and financial stability when difficult trade-offs emerge. “Growth matters, but stability is the foundation upon which sustainable growth is built,” he said.
BI unexpectedly raised its benchmark rate by 25 basis points to 5.5 per cent, its second increase in three weeks, saying the move was needed to support the rupiah and maintain economic stability.
The decision came just days after parliament amended the Financial Sector Development and Strengthening Law, requiring BI to support policies that promote growth and create jobs.
Baskoro warned that tensions could arise when efforts to support growth conflict with the need to defend the rupiah or contain inflation. “Supporting growth may call for lower interest rates, while defending the rupiah may require higher rates. It’s a bit like pressing the accelerator and the brake at the same time. ...If investors become unsure whether BI is prioritising growth, inflation or exchange-rate stability, risk premiums rise and policy credibility weakens.”
The latest legal changes also introduce a mechanism for the early removal of BI board members before the end of their terms.
Although any removal would require reviews by the House of Representatives, rather than direct action by the government or president, analysts warned that the provision could still weaken market perceptions of BI’s autonomy.
“The concern is the emergence of an institutional risk that BI officials could lose their positions because of political assessments of their policy decisions,” said Achmad Nur Hidayat, an economist and public policy expert at UPN Veteran Jakarta.
The central bank has pushed back against concerns that supporting growth could dilute its commitment to stability. BI says it supports the legislative changes and will continue to work with the government in implementing economic policies. “BI continues to strengthen its policy mix and coordinate with the government, the House of Representatives and other stakeholders to maintain economic stability while contributing to sustainable economic growth,” a spokesperson said.
After the surprise rate hike, BI signalled that it is prepared to allow bond yields to rise and left the door open for further interest-rate increases, as it seeks to attract capital back to the economy.
Analysts said the recent rate hikes lend credence to that. Patrick Zweifel, chief economist at Pictet Asset Management, noted that BI’s surprise rate hike signals a clear focus on currency stability, with the rupiah rebounding after recent pressure from a stronger US dollar, higher oil prices and elevated global risk aversion. However, he wondered if higher rates alone can sustain foreign inflows as investors increasingly focus on policy credibility over yield differentials.
Natixis senior economist Trinh Nguyen said that investors are increasingly concerned about the fiscal impact of President Prabowo Subianto’s spending agenda, including expanded subsidies and social programmes, as higher oil prices add to budget pressures.
She added that the rupiah has also come under pressure amid concerns over tighter government control of commodity exports.
The 1998 shadow returns
The expanded mandate has reignited debate among investors and economists over whether Indonesia is drifting away from the institutional framework established after the 1997-1998 Asian financial crisis.
Professor Didik Rachbini, senior economist and founder of Jakarta-based Institute for Development of Economics and Finance, said that today’s debate resonates strongly with investors as it touches on one of the key reforms that reshaped Indonesia’s economics after the fall of former president Suharto.
Prof Didik, who served on former president BJ Habibie’s national reform team for economic affairs, said that the reforms helped restore investor confidence and stabilise financial markets in the aftermath of one of Indonesia’s worst economic crises.
The rupiah, which had plunged to around 16,500 per US dollar during the Asian financial crisis, later strengthened to about 6,500 as investor confidence returned and economic reforms took hold.
“The key lesson is that investor confidence is closely tied to institutional credibility, policy predictability and the perception that economic institutions operate independently and according to clear rules,” noted Prof Didik.
Ratings pressure adds to scrutiny
The concerns come as policymakers grapple with a weakening rupiah and slowing capital inflows, while rating agencies also step up scrutiny of Indonesia’s policy and institutions. The rupiah has lost more than 8 per cent against the US dollar this year, ranking among Asia’s weakest-performing currencies. Foreign investors have pulled roughly US$3.4 billion from Indonesian assets amid concerns over fiscal policy, governance and global market turbulence.
Moody’s and Fitch have cut their sovereign outlooks to “negative”, reflecting concerns over weakening policy credibility and fiscal risks, while S&P has signalled that maintaining Indonesia’s investment-grade standing will depend on efforts to rebuild fiscal buffers.
Edward Gustely, managing director of Penida Capital Advisors, said BI’s expanded mandate could affect investor confidence. “If markets begin to perceive that monetary policy is being captured to finance short-term political objectives, Indonesia could face a structural increase in its cost of capital.”
Closer policy coordination
The expanded mandate comes amid increasingly close coordination between BI and the government. Since taking office in 2024, Prabowo has pushed an aggressive growth agenda aimed at lifting Indonesia’s economic growth rate to 8 per cent. As part of that effort, he has repeatedly called on state-owned banks to expand lending to small businesses and support government priorities, including a programme to build three million affordable homes for lower-income households.
Investor concerns intensified last year when BI agreed to buy 200 trillion rupiah (S$14.4 billion) of government bonds under a burden-sharing scheme designed to help finance Prabowo’s flagship programmes. Concerns were further amplified earlier this year when Prabowo’s nephew Thomas Djiwandono was appointed deputy governor of the central bank.
