Indonesia’s central bank faces growing threats to independence
As governments look to raise spending and borrow more, investors have reacted by selling longer-dated bonds in US, Europe and Japan
[SINGAPORE] Indonesia’s finance minister once wanted to run the country’s central bank. Now, he just wants to tell it what to do.
Purbaya Yudhi Sadewa, who rose from relative obscurity to become one of Indonesia’s most powerful officials, has told friends and colleagues over the years that he does not believe the central bank should be independent, according to sources familiar with the matter. The nation’s populist leader, Prabowo Subianto, agrees with him, the sources said.
That is ramping up pressure on a central bank now facing threats from multiple quarters. In just the past month, Bank Indonesia (BI) has revived a Covid-era “burden sharing” agreement it previously said that would be used in moments of crisis, faced the risk of legal changes that would make it easier for politicians to kick out senior officials and watched lawmakers weigh amendments to its official mandate.
These moves have profound implications for global funds, who hold more than US$200 billion in Indonesian assets, according to Bloomberg-compiled data. Bond investors are already concerned about a growing budget deficit, and the changes discussed raise questions over the central bank’s role in funding spending and its focus on controlling inflation. As a sign of concern, the currency is trading around levels seen during the Asian financial crisis.
“Indonesia’s new paradigm looks less like coordination and more like turning independence into compliance,” said Harry Baskoro, senior fellow at the Centre for Indonesian Policy Studies and a former economist at the central bank.
Fears of fiscal largess and eroding central-bank independence have fuelled the worst month of outflows from Indonesia’s bond market in more than three years, according to Bloomberg-compiled data.
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But Purbaya downplayed the concerns over the central bank and the fiscal deficit in an interview with Bloomberg Technoz on Tuesday (Sep 30). BI is focused on its duties in accordance with the law, and a “burden sharing” arrangement, under which the central bank helps cover debt costs for Prabowo’s priority programmes, should remain temporary, he said.
The finance minister also said that he will not ease fiscal restraints until he can show the economy has grown faster with more efficient spending. Still, he noted that restrictions on debt and deficits are arbitrary, and other countries have violated them.
The nation’s Ministry of Finance declined to comment for this story. BI did not respond to a request for comment.
Fiscal dominance
For decades, central-bank independence has been a cornerstone of global markets, with interest-rate decisions driven by economic data rather than political needs. That makes it easier for money managers to plan investments. Now, that foundation is getting eroded.
US President Donald Trump has led the charge against monetary policymakers, defying decades of convention by pushing the US Federal Reserve to speed up interest rate cuts and trying to muscle out a board member. The pressure against central banks globally is gathering steam, fuelling worries among investors about so-called fiscal dominance, a situation where monetary policy becomes subordinate to fiscal spending or government debt burdens.
“The fact is we have all been central bank watchers for the last 20 years, and that’s completely flipped around,” said Howe Chung Wan, head of Asia fixed income at Principal Asset Management. “Fiscal dominance is a key theme in markets now.”
As governments look to raise spending and borrow more, investors have reacted by selling longer-dated bonds in US, Europe and Japan. If central banks are also pressured into cutting interest rates to lower debt burdens, as Trump is asking the Fed to do, the concern is that currencies will weaken and inflation will spiral again.
The recent bond outflows from Indonesia came even as the nation’s debt markets rallied on a series of interest-rate cuts, with a Bloomberg gauge of its local currency bonds showing a return of over 9 per cent this year.
Allianz Global Investors reduced its exposure both to the rupiah and to the country’s government bonds, said Ze Yi Ang, a portfolio manager at the firm. Indonesian bonds now form a “moderate portion” of the fund’s pan-Asian mandates, said Ang, who is part of the Asia-Pacific fixed-income team that manages about US$6 billion.
The rupiah lost around 1 per cent against the US dollar in September, and is one of Asia’s worst-performing currencies this year. It is now close to the all-time low it set in April, as Trump’s tariffs roiled global markets.
Foreigners account for around 40 per cent of Indonesia’s stock market and own 14 per cent of the government debt, according to official and Bloomberg-compiled data.
It has not all been bad news. The Jakarta Stock Exchange Composite Index rose 3 per cent in September and is trading around record highs, with local buyers making up for a pullback from global investors.
The stock performance underscores a conundrum facing investors: Although the combination of fiscal stimulus and central bank easing can ignite inflation, leading to volatility in currency and bond markets, it can also send stock prices surging as corporate revenues jump.
The threats to BI challenge years of progress. When researchers at the European Central Bank (ECB) analysed studies of central-bank independence five years ago, they found that BI was ranked one of the most independent in the world – more than the Fed, the Bank of Japan or even the ECB itself.
That autonomy is unlikely to be legally abandoned, with some investors more concerned about the government wielding informal influence. But the amendments being considered in Indonesia’s parliament underscore the potential for legal threats. The suggestion to make it easier for politicians to remove BI officials, in particular, would raise pressure on central bankers to toe the line.
“I am worried that the institutional safeguards that have underpinned macro stability in Indonesia appear to be coming off,” said Kaimin Khaw, a global macro strategist at Loomis Sayles. “Erosion of central-bank independence has often ended badly in emerging markets, and should serve as a cautionary tale.”
Bold plans
Sources familiar with Purbaya say he’s a risk-taker, eager to find decisive solutions to complicated problems. Purbaya previously expressed a desire to run the central bank, the sources also said. He is a fan of Milton Friedman, the iconic University of Chicago economist who stressed the importance of the money supply for influencing economic activity and inflation.
Purbaya has started his new job with a bang: Since his inauguration on Sep 8, he has injected US$12 billion of government funds into banks to boost lending, unveiled a welfare package worth nearly US$1 billion, raised the 2026 state budget and signalled a willingness to lift legal caps on both the fiscal deficit and the national debt.
These moves align him closely with Prabowo, who has ramped up welfare spending and pledged to lift economic growth to 8 per cent, higher than it has been in decades. But they have also fanned fears that Indonesia’s government is too willing to spend, risking a burst of inflation that would be exacerbated by a pliant central bank.
Higher growth would benefit the bond market if it means a lower debt-to-GDP ratio, reducing concerns around perceived default and fiscal risks.
The immediate concern is how the central bank balances the pressure to support growth and fiscal spending with its desire to protect the currency, an official part of its mission statement. Since the Asian financial crisis, BI has developed a track record of acting aggressively in defence of the rupiah, at times surprising investors with rate hikes.
This time around, it is surprising in the other direction. The central bank has cut interest rates for three consecutive meetings, defying most economists’ predictions that it would stand pat and pledging to go “all-out” to support growth.
BI governor Perry Warjiyo has promised bold action to stabilise the currency, but some Wall Street banks say the worst is not over yet: Analysts at Goldman Sachs predict the rupiah will continue to lag its peers in Asia ex-Japan over the coming months, pointing to fiscal worries and the likelihood of more rate cuts.
And although the interest rate cuts and fiscal stimulus moves have helped push up stock and bond prices, overseas investors remain nervous. Indonesia ranks at the bottom of Asian equity markets among the region’s fund managers, according to a Bank of America survey conducted in early September. Foreign investors sold a net US$234.5 million of stocks last month, according to Bloomberg-compiled data.
Indonesia, like other governments ramping up pressure on their central banks, is getting cover from the US. It is not simply because Trump’s criticisms of Jerome Powell have challenged decades of convention. The likelihood of more Fed rate cuts to come also helps, since it means unexpected cuts elsewhere will cause less market disruption.
The government is also relying on local investors to fill the breach as global funds back away. The country’s newly established sovereign wealth fund, Danantara, is close to sealing US$3 billion of so-called patriot bonds, after calling on the nation’s tycoons to buy debt at levels well below market rates.
But investors and strategists warn that even if the near-term risks prove to be manageable, the real impact will be felt during moments of crisis, when global funds often rely on level-headed central bankers to steady the ship.
“In the case of Bank Indonesia or even the Fed, the lack of credible policymaking will likely show up when the backdrop turns more negative – either with risks of recession going up or inflation surging,” said Aroop Chatterjee, a strategist at Wells Fargo in New York. “That’s when it will be hard to calm markets and have them buy into whatever policy solution is put on the table.” BLOOMBERG
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