Indonesia’s credibility reset

Indonesian assets have been priced for a policy problem. Our recent meetings in Jakarta point to an economy that is more resilient, and a policy mix more orthodox, than this year's underperformance suggests.

Our recent research trip to Jakarta, covering policymakers, the central bank, multilateral institutions, sovereign investors, and local banks, left us with a clear conclusion. Indonesia's difficult first half, characterised by underperforming equities and local bonds, a rupiah at record lows, and a sharp retreat by foreign investors, was a credibility event rather than a structural one. Growth is holding close to trend, inflation is contained, the banking system is well capitalised, and the external position is adequately buffered. What changed was investors' confidence in the policy framework, and that confidence is now being rebuilt. There is still work to do, and some risks deserve close attention, but in our view the worst of the repricing is behind us.

A credibility event, not a structural one

The fundamentals have held up better than market pricing implies. Growth came in at 5.29% in the second quarter, in line with Indonesia's long-run trend, and credit growth has accelerated to more than 13%, led by investment lending. Headline inflation was 3.28% in September and core inflation 2.84%, both inside Bank Indonesia's 2.5% ±1% target range. Banks hold capital well above regulatory minimums, with non-performing loans close to 2%, and the trade balance returned to a solid surplus in August.

The pressure on Indonesian assets came largely from within. Analysis of the rupiah's drivers that we reviewed in Jakarta suggests that global factors, including the US dollar and global risk appetite, were broadly supportive for much of the period, while domestic investor sentiment explained most of the currency's weakness. That sentiment was shaped by a fiscal stance increasingly perceived as growth at all costs, by a growing share of public activity running through state-owned enterprises and the new sovereign wealth fund, and by index-related outflows from equities. Foreign investors responded decisively. Their share of the local government bond market has fallen to around 13%, close to a decade low. None of this reflects a loss of growth capacity, a fragile banking system, or an external funding gap. It reflects concerns about policy predictability, and policy is precisely what has just changed.

Two reassuring appointments

The most important development for investors this year is the change in leadership at the two institutions that matter most for local markets.

At the Ministry of Finance, Suahasil Nazara has replaced Purbaya Yudhi Sadewa. A career fiscal technocrat, former head of the Fiscal Policy Agency and Vice Minister of Finance, Mr Nazara has made budget credibility, clearer communication with markets, and adherence to the 3% deficit ceiling his first priorities. The appointment was welcomed across every meeting we held, and rating agencies have already engaged with the new minister directly.

At Bank Indonesia, Governor Destry Damayanti brings deep institutional experience at a time when the central bank's role in supporting both the currency and growth has become increasingly important. Bank Indonesia has held its policy rate at 5.75%, kept rupiah stability at the top of its agenda, and relied on a broad toolkit that includes FX intervention, hedging incentives, and macroprudential measures rather than rates alone. Taken together, the two appointments signal a return towards policy orthodoxy and represent reassuring first steps in restoring the credibility premium Indonesia lost this year.

Monetary policy steps forward

The 2027 budget reinforces this shift. It targets a deficit of 2.40% of GDP, down from an expected 2.85% this year, with a primary balance close to zero, revenue growth driven by better tax compliance, and flagship programmes such as free school meals reset to more realistic levels.

With the budget no longer the main engine of growth and inflation well contained, we expect monetary policy to move back to the forefront and take on more of the heavy lifting.

Bank Indonesia's mandate now explicitly includes supporting growth alongside currency stability. The large stock of central bank bills that has kept short-term yields well above the policy rate also gives the central bank room to ease financial conditions when stability permits. Policymakers noted that transmission tends to work more through bond yields and the exchange rate than through bank lending rates. This creates a supportive backdrop for the short and intermediate segments of the local curve.

The long end has less to gain. The credibility improvement is now largely priced in, government bond supply will remain heavy in 2027, and spreads over US Treasuries are thin by historical standards. In our view, Indonesia is well positioned to be one of the first curves in the region to steepen.

Stability over direction for the rupiah

Currency stability remains Bank Indonesia's overriding operational priority. The central bank intervenes across spot, forwards, and the offshore non-deliverable market. It has widened its hedging incentives and tightened rules requiring natural resource exporters to repatriate and retain their earnings onshore. Reserves of approximately USD 148bn are adequate according to IMF metrics, although they are not abundant and have already declined this year.

The result is a currency managed for low volatility rather than directional appreciation. With the US dollar still strong and some outward investment by state-linked entities likely, we see the outlook for the rupiah as neutral to modest depreciation rather than a source of sustained strength.

The fiscal grey zone

It would be misleading to present the policy reset as complete. The principal concern raised during our meetings was not the headline deficit but what lies around it.

A meaningful share of public investment and support now runs through state-owned enterprises, state banks, and Danantara. Multilateral institutions were candid that this makes the true fiscal stance difficult to measure. Tax refund delays have flattered revenue this year, and government and state-linked borrowing needs will remain substantial in 2027. Until quasi-fiscal flows are disclosed more fully, investors will continue to apply a credibility discount. Delivering greater transparency is, in our view, the most important test facing the new finance minister.

Growth: ambition versus reality

The government's ambition is to achieve growth well above the 5% Indonesia has delivered for most of the past decade. Domestic participants were sceptical that the gap can be closed quickly. Household spending remains uneven across income groups, private investment is concentrated in commodities, renewable energy, and data centres where returns are clearest, and the downstreaming strategy in nickel has delivered less than hoped.

We expect another year of growth around 5%. The risk is that a gap between ambition and outcome encourages policymakers to return to off-budget stimulus measures, undoing some of the credibility now being rebuilt.

Two external risks also stand out. A renewed surge in the US dollar would force Bank Indonesia to prioritise currency stability over growth, delaying any easing cycle. Higher oil prices would either increase the subsidy burden or, if fuel prices are adjusted, push inflation higher. Neither is our central scenario, but both would complicate the policy mix.

Bottom line

Against an emerging-market backdrop characterised by elevated US rates and heightened sensitivity to policy credibility, Indonesia's setback this year looks more like a correction in confidence than a deterioration in fundamentals. Growth remains near trend, inflation is contained, banks are strong, and the appointments at the Ministry of Finance and Bank Indonesia mark a credible return toward policy orthodoxy.

The test now is execution. Fiscal transparency, the management of state-linked spending, and communication with markets will determine whether the credibility reset proves durable. If the new policy team delivers on those fronts, Indonesia is well positioned to win back the investors it lost this year.