Behind Fitch’s warning: Why revising Indonesia’s State Finance Law matters for investors

[JAKARTA] Indonesia’s longstanding track record of maintaining fiscal discipline is being put to the test, posing a challenge to investor confidence.

The proposed revision to Indonesia’s State Finance Law has been under sharper scrutiny since it was cited by Fitch Ratings in a commentary revising the country’s sovereign outlook to negative from stable.

Fitch said plans to review the fiscal framework could weaken policy credibility and raise concerns about the government’s ability to finance higher fiscal deficits. The agency also pointed to signs of increasing centralisation in policymaking, as Indonesia considers expanding the role of Bank Indonesia (BI).

Fitch’s concerns were echoed by other analysts who flagged similar risks.

Teuku Riefky, an economist at the University of Indonesia, said Fitch’s concerns reflect broader worries about the perceived weakening of BI’s independence, which could undermine the quality of monetary policy going forward.

Radhika Rao, senior economist at DBS, said a negative outlook change typically reflects a cautious view on the sovereign, opening the window for follow-up action over the next 18 to 24 months.

What is the law?

Indonesia enacted the State Finance Law in 2003 in the aftermath of the Asian financial crisis, replacing the outdated financial regulations that had governed the country during the New Order era.

The legislation marked a key milestone in the reform process of South-east Asia’s largest economy as it sought to rebuild its institutions following more than three decades of rule under president Suharto.

The law establishes a strict budget deficit ceiling of 3 per cent of gross domestic product and sets clear thresholds for overall government debt levels. The rules were designed to restore market confidence after Indonesia faced a period of mounting debt.

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The law underwent significant changes in 2023, when it was revised into an omnibus framework that consolidated various financial regulations, including provisions that reaffirmed Bank Indonesia (BI) as the authority responsible for implementing monetary policy.

Under the current legal framework, BI operates as an independent central bank with a primary mandate to maintain the stability of the rupiah, keeping inflation under control and safeguarding financial system resilience.

What does the Bill entail?

BI’s monetary policy role faces new challenges as President Prabowo Subianto pursues an ambitious 8 per cent growth target, well above Indonesia’s historical average of around 5 per cent.

On several occasions, Prabowo has called on BI to strengthen coordination in supporting growth, including financing flagship programmes such as a plan to construct three million houses for the country’s low-income population.

The government and BI also revived a Covid-era “burden-sharing” agreement previously intended only for crisis periods.

In September 2025, Prabowo replaced finance minister Sri Mulyani Indrawati with economist Purbaya Yudhi Sadewa.

Amid mass layoffs and weakening household demand, Purbaya pledged to steer Indonesia’s economy through a period of declining public confidence following large-scale protests in August, committing to policies aligned with Prabowo’s economic growth target.

The agenda includes reviewing the State Finance Law to strengthen fiscal and monetary coordination. The Bill is currently under parliamentary review and is included in this year’s legislative priorities.

Triggering scrutiny

The planned revision, however, has prompted debate in the market. At the centre of the debate is a possible recalibration of BI’s role and whether its mandate should be broadened to explicitly include support for economic growth and job creation.

Market concerns have also emerged that the government may revise the fiscal deficit cap of 3 per cent, although Purbaya has repeatedly stressed that fiscal discipline will remain intact.

Perceptions of government influence over the central bank intensified after Thomas Djiwandono, Prabowo’s nephew and a deputy finance minister, was appointed as a deputy governor of BI in January.

Concerns over BI’s independence have also intensified amid a broader global trend of perceived erosion in central bank autonomy, including pressure from US President Donald Trump on the Federal Reserve.

Rising worries over fiscal expansion and potential institutional weakening have contributed to the worst bond market outflows in more than three years. The rupiah weakened to near a record low of 17,000 per US dollar in late January, prompting multiple interventions by BI in the spot market.

However, Purbaya has downplayed those concerns in interviews with local media, defending the stance on fiscal policy and monetary coordination.

Although the government describes the revision as part of broader efforts to strengthen economic governance and improve coordination between fiscal and monetary authorities, detailed provisions remain unclear.

The mere prospect of change has already attracted scrutiny from investors and rating agencies. In its commentary, Fitch warned that requiring the central bank to take on a larger role in promoting growth and employment could complicate the execution of monetary policy.

“A more dovish policy stance, combined with a potential expansion of its mandate, may make it more challenging for BI to achieve its core objectives of maintaining inflation control and safeguarding exchange rate and financial stability, particularly if capital outflow pressures intensify,” it said.

Change may be necessary

Meanwhile, supporters of the revision argue that a more flexible framework is needed in a rapidly changing global environment. A broader mandate, proponents say, would give BI greater scope to support the government’s economic agenda during downturns.

Fakhrul Fulvian, chief economist at Trimegah Sekuritas Indonesia, said Indonesia’s financial legal framework was shaped in the aftermath of the Asian financial crisis, when inflation control and fiscal discipline became the foundation of laws governing BI.

“These rules were designed to preserve stability and enforce strict deficit control,” he said.

However, Fakhrul argued that the global environment has changed significantly.

The inflation-targeting framework was built on the assumption that supply shocks were rare. Yet, today, repeated disruptions from pandemics, wars, energy crises, climate change and technological shifts have made such shocks more frequent.

“Applying the old framework in this context may require tighter monetary policy to contain inflation, which could suppress output and lead to a prolonged negative output gap,” he said.

Indonesia recorded low inflation in 2025, giving BI room to ease monetary policy by cutting interest rates by 125 basis points. However, credit growth remained in single digits, below targets set by the government and financial authorities.

Indonesia’s economy grew by 5.11 per cent in 2025, a slight acceleration from the previous year, but short of the government’s 5.2 per cent target.

Fakhrul said Indonesia now faces a “double squeeze”: Supply shocks push prices higher while production weakens, and tighter monetary policy combined with rigid fiscal limits further constrains demand.

“Without greater countercyclical fiscal space, these pressures could deepen economic losses.”