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Policy shifts

Policy changes have followed since protests escalated in August (Indonesia: Protests, politics and policies). The evolving policy mix is likely to see stronger coordination between fiscal and monetary policies, besides a deeper rate cut cycle than we had earlier assumed. Financial markets have given the benefit of the doubt to the currency and bond markets, though investors do remain sensitive to political economy developments.

The evolving policy mix has four takeaways:

A shift from fiscal orthodoxy

Following the cabinet reshuffle, Finance Minister Purbaya assumed office in early September. Since 2013, barring the Covid years of 2020-2021, fiscal deficit has averaged -2.3% of GDP, well below the -3.0% of GDP threshold, undershooting budgeted targets for much part. We expect a shift from traditional fiscal orthodoxy, implying a bigger role for public spending in supporting growth and playing a complementary role in attracting private sector participation. The contours of this shift will be important to monitor to ensure that the broader agenda towards pursuing fiscal accountability is not diluted.

The change is evident in three developments:

#1 Fast track 2025 expenditure

The fiscal run-rate in the first eight months of 2025 continued down the path of below-target revenue growth and a modest pickup in expenditure. Jan-Aug25 revenue growth was down -7.2% yoy, while spending was up a modest 1.5% yoy. Both revenue and expenditure are trailing at a 55-57% mark of the full-year budget by August.

Slower spending to date is a function of expenditure cuts at the start of the year to the tune of IDR 307trn (8-9% of total expenditure), targeting non-developmental and wasteful outlays. This was followed by lagging disbursements towards flagship programs due to administrative and operational hurdles. The nutritious meal program has disbursed less than a third of the full-year budget, with realised spending on the community schools at 6.5% by August. Infrastructure spending (connectivity, food security, and energy security) stood at 35% of the full-year budget by August, vs. allocated IDR402.4trn.

While this captures data before a change in guard at the Finance Ministry, we expect a faster catch-up in disbursements from September onwards.

#2 Build headroom by raising the 2026 fiscal deficit target.

Next year’s deficit target was widened to -2.68% of GDP vs. -2.48% set earlier to accommodate an increase in spending while adhering to the -3.0% of GDP mandated threshold. Total expenditure was raised by IDR 56trn to IDR 3843trn, to accommodate higher allocations towards regional governments (IDR 693trn vs IDR 650trn earlier). Free meal program (IDR 335trn) and jump in defence spending. We recall that the proposed cut in regional/ provincial funding in the previous draft budget had contributed to the groundswell during recent protests.

Underlying growth (5.4%, DBSf 5%) and revenue assumptions are optimistic. A material lift to the tax-to-GDP ratio towards the targeted 10.5% of GDP vs. the sub-10% average in the previous ten years, requires a combination of fresh tax-generating avenues as well as higher due diligence to improve collections/ broaden the tax base. An increase in the VAT rates (low probability), amnesty programs, or royalty fees might be potential areas to explore.

It is unclear if the higher deficit in 2026 will be accompanied by higher bond issuances. We assume that the additional IDR 50bn (final vs. draft) budget balance will be absorbed through adjustments within other heads to avoid higher borrowings. Notably, the utilisation of the government’s cash balance (SAL initial estimate at IDR 60trn vs IDR 86trn in 2025), coupled with directed financing options for village cooperatives and housing programs, will also lower the need to increase debt supply.

We maintain our forecast for 2025 and 2026 deficits to widen but stay close to the -3% of GDP threshold without breaching the level. (DBSf: -2.9%). If deficit slippage risks rise, spending levers are likely to be utilised to prevent an overshoot, as revenues continue to remain weak. Fiscal path might undergo a change 2027 onwards.

#3 Stimulus measures and non-rate measures

Amongst the first few steps taken by the new Finance Minister was a decision to release IDR 200bn (~$12bn) worth of liquidity from the state’s cash balance at BI to the state-owned banks to spur lending activity (New Finance Minister takes action).  BI’s liabilities with the central bank topped IDR 490trn by late 2024, which, together with the issuance of SRBIs, was seen as soaking up liquidity from the domestic banking system. Liquidity markers are, however, already in ample territory, suggesting that any positive impulse to credit activity will also need an improvement in demand from households and corporates.

The government announced another tranche of stimulus measures worth IDR 16trn (0.06% of GDP), referred to as the “8+4+5” package i.e., eight short-term acceleration steps in Sep-Dec 2025, a few of which will be extended in 2026, and five longer-term initiatives targeting labour absorption. Measures in 4Q aim to address a few of the livelihood demands of protesters, including the extension of food aid (e.g., rice supplies), tax exemptions for workers in the tourism sector, work accident/unemployment insurance coverage for motorcycle taxi drivers, funded internships for fresh graduates, amongst others. Bonds were unperturbed by the modest scale, amidst assurances that the existing budget outlay will absorb the fiscal cost. Meanwhile, there are indications of additional stimulus at the tail end of 2025.

The 2026 agenda could include a change in policy priorities.

A total of 67 bills have reportedly been approved to enter the 2026 Priority National legislation Program[1] during the Plenary Meeting of the parliament in September. Plans to revisit the 2003 law on state finances. This has captured much interest, as this law regulates fiscal and public debt limits, which stand at -3% of GDP and 60% of GDP, respectively. The 2024 fiscal deficit was at -2.3% of GDP, and debt at a shade below 40% of GDP.

Other bills that might be considered include re-tabling the Asset Forfeiture Bill to strengthen the legal framework for asset recovery, tax amnesty, and a further tranche of patriot bonds, likely encouraged by the positive response to the recent issuance of such papers. We expect the agenda to evolve in the coming months, which will provide the medium-term priorities of the government. At this juncture, the government is focused on higher social sector spending and purchasing power support.

Dovish monetary policy bias as growth trumps rupiah stability as a monetary policy goal

Bank Indonesia undertook a two-step policy easing move in September.

In a surprise move, the benchmark rate was lowered by 25bp to 4.75% for a third consecutive month. The policy corridor was widened with a larger 75bp cut in the overnight deposit facility to 3.75% to guide money market rates/ INDONIA lower. All hands are on deck to support growth by not only increasing liquidity but also lowering costs, as evidenced by successive rate cuts, a push to hasten policy transmission, a reduction in SRBI issuances, coinciding with the government’s move to infuse liquidity and introduce “8+4+5” stimulus measures.

The buffer from domestic real rates is ample (~240bp), with the recent stickiness in food inflation likely viewed as supply-driven (and temporary), and thereby less consequential for rates. Exogenous forces are also conducive, with a resumption of US Fed rate cuts to rewiden the ID-US benchmark rate differentials and promote rupiah stability.

The central bank opined that the negative output gap might close by late 2026 or early 2027, hinging on incoming data, suggesting rates will stay low in 2026 as well. Given the central bank’s recent action, dovish cues, signs of BI-government policy coordination, and upcoming US Fed cuts, we build on one cut for BI in 4Q25 to 4.50%, and another 25bp in 1Q26 to 4.25%. We would not be surprised if the 50bp cut gets frontloaded to 4Q25.

Concurrent to rate cuts, BI also reintroduced the ‘burden-sharing’ arrangement with the government to support priority programs under the President’s Asta Cita agenda, especially housing and village cooperatives agenda. While this arrangement will not involve the BI issuing new bonds, it will be a cost-sharing arrangement on interest rates. Nonetheless, BI has committed to purchasing bonds in the secondary market, continuing the arrangement established over the past few years. Purchases of government bonds as of mid-September amounted to IDR 217.10trn, including secondary market purchases and a debt switching program with the Government, totalling IDR 160.1trn. With the central bank now holding about a quarter of outstanding bonds, caution over fiscal dominance has risen. To prevent such debt purchases from being perceived as partial debt monetisation or quantitative easing, it is preferable to keep to pre-defined limits and ensure that the overall scale is contained.

Domestic growth anchor and tie-ups with non-US partners.

The U.S. tariff on Indonesian goods settled at 19%, largely in line with the majority of Asean peers. Reports suggest that key Indonesian agro-industrial exports, including cocoa, palm oil, and rubber exports, are on course to be exempted from the new tariff rate[2], with an official confirmation pending. Indonesia had concluded a trade deal with the US back in July, under which 99% of tariff barriers for a full range of U.S. industrial and U.S. food and agricultural products were lowered, in exchange for the tariff reduction. Indonesia had also reportedly agreed to buy $15 bn of U.S. energy, $4.5 bn of farm products, and 50 aircraft jets. The nuances of the deal and a product-wise breakdown are still under study.

In the meantime, the administration is strengthening ties with non-US trading partners. A case in point was the successful conclusion of the Comprehensive Economic Partnership Agreement (CEPA) with the European Union that followed the official launch of negotiations in July 2016. This marks the EU’s third deal in Southeast Asia, following agreements with Vietnam and Singapore. The EU accounted for a 7.5% share in Indonesia’s exports in Jan-Aug25, led by trade with Germany, Italy, and the Netherlands. Indonesia is the EU’s 33rd biggest trading partner, and the EU’s fifth-largest ASEAN trading partner in 2024. Bilateral trade stood at ~$32 bn last year. For both countries, this would mean the removal of import duties on most tariff lines and simplifying procedures for EU goods exports to Indonesia, including key exports such as cars and agri-food products, and vice versa. The deal will be fully implemented by January 2027.

Separately, Indonesia concluded a bilateral trade deal with Peru in August 2025 and signed another with Canada in September 2025. The former added $480 mn to bilateral trade in 2024, consisting of footwear, biodiesel, cars, and components, etc. The latter was Canada’s first trade deal in Southeast Asia.

Implications for growth, markets and policy

The upside surprise in 1H25 at an average 5% yoy was put to consumption of high-value services and goods, also benefiting from more public holidays and religious festivities, which improved consumption. A material lift in business at SEZs, for instance, was also said to have added to the buoyancy in 1H momentum. We expect a moderation in the second half due to the passage of long weekends, higher external uncertainty, protests, and the related impact on confidence and back-loaded government spending. Multiple tranches of stimulus measures and a 50% jump in the goods trade balance between 8M24 and 8M25 will provide support to growth. To factor in stronger 1H growth, we marginally adjust our 2025 growth to 4.9%. Near-term spending measures are focused on consumption by vulnerable households, and productivity is likely to improve only in the medium term. We mildly raise 2026 forecast to 5% from 4.9% on expectations of a shift away from a defensive fiscal policy stance.

Markets have given the benefit of doubt to IDR assets (FX Daily: Giving Indonesia the benefit of the doubt), demonstrated by bonds and the currency staying within familiar ranges, barring knee-jerk volatility. BI’s bond purchases are likely to be largely steady, premised on the view that borrowings might not be raised to accommodate the higher deficit number in 2026. The long end of the curve will, nonetheless, be sensitive to plans to revisit the statutory fiscal thresholds, as well as any compromise to the central bank’s independence or its mandate, next year. For now, we expect the curve to stay steep, with more room for a pullback in short-tenor yields. Spikes in 10Y yield present attractive entry levels. Our FX forecast (link) for modest gains in the rupiah by year-end is premised on a softer dollar and stabilisation in the domestic political economy.

[1] Press
[2] Article


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