Indonesia’s economy stress test: A story of growth versus discipline

Indonesia’s economy has always had potential.

It’s a story about a young population, abundant resources, and rising investment have placed it among the world’s most closely watched emerging markets.

Even so, this promise has often collided with political realities. That collision is happening again.

President Prabowo Subianto has replaced his respected finance minister, Sri Mulyani Indrawati, with an economist who promises rapid growth and no new taxes.

Markets clearly reacted. Equities dropped 1.3% on the news, the offshore rupiah weakened against the dollar, and sovereign bonds slipped.

The government’s credibility premium, built painstakingly over two decades, is now being tested.

How will changing policy affect a strong base?

Indonesia’s macro base was steady before the reshuffle. GDP grew 4.9% year on year in the first quarter and 5.1% in the second quarter, even exceeding World Bank’s medium-term forecast of 4.8% through 2027.

Inflation cooled to the low-2% range by mid-year. Bank Indonesia responded by cutting rates five times since September 2024, most recently in August, lowering the policy rate to 5%, although a pause was expected.

External balances looked manageable. The current account deficit narrowed sharply in early 2025, partly due to softer imports and still-resilient commodity receipts.

Bank Indonesia expected the full-year deficit to stay within 0.5-1.3% of GDP. Nickel, coal, and palm oil remained key export pillars, though volatile global prices underlined the risk of swings in external financing conditions.

Fiscal policy, however, was already under strain. The government’s free school meals program, which is Prabowo’s flagship pledge, was designed to feed more than 80 million Indonesians.

By June, only 2.6% of the 2025 allocation had been disbursed, reflecting logistics bottlenecks and weak administrative capacity. Analysts estimated its cost at roughly 1.5% of GDP if scaled fully.

Adding defense expansion and capital relocation plans raised questions about how to keep the deficit under the legally mandated 3% ceiling.

The new minister’s bold promise

Purbaya Yudhi Sadewa is the country’s new finance minister, sworn in at the presidential palace on Monday.

Purbaya promised faster growth through joint state and private-sector investment. He dismissed the need for new taxes and said strong growth would calm social unrest.

He suggested that 6 to 7% growth would make protests “disappear” as citizens turned to jobs and rising incomes.

Markets struggled to interpret the message. The rupiah briefly strengthened by 0.7%, its sharpest intraday move in two months, before settling flat.

Offshore forwards weakened on fiscal concerns. Bonds fell, with the 2045 dollar issue losing 0.33 cents to 97.58 cents. The split reaction was a clear reflection of uncertainty. Investors had no doubt about Sri Mulyani’s credibility. With Purbaya, they must wait for proof.

Source: Bloomberg

Analysts also voiced their concern immediately.

Capital Economics warned that he might prove more pliant to presidential demands, risking looser fiscal rules and pressure on the central bank.

Natixis questioned how the government would fund both the meals program and higher defense spending without breaking the deficit cap.

Maybank pointed to the risk of volatility in the rupiah until new policies were clarified. The common thread was the fear of slippage on fiscal anchors.

The credibility triangle

Indonesia now faces what can be called a credibility triangle. At one corner lies the deficit rule, capping the shortfall at 3% of GDP.

At another sits the promise of no new taxes.

And at the third is the growth target of 6-8%, paired with ambitious spending.

Investors believe the government can reliably deliver on two of these corners, but not all three. The challenge is choosing which priority bends, and how transparently.

The draft 2026 budget pointed to a deficit near 2.5% of GDP with balance by 2027 or 2028.

But without new revenue measures, keeping that path requires either reprioritizing programs, boosting non-tax revenue, or relying on off-budget maneuvers.

The market will price in the difference. Transparent trade-offs will help. Creative accounting will not.

Central bank pressure and market risk

Bank Indonesia sits in the middle of this adjustment. Its rate cuts show confidence in inflation trends, but fiscal uncertainty could limit its room to ease further.

Analysts expect the central bank to intervene more actively in the currency market to smooth volatility. Intervention can buy time, but it cannot substitute for a credible medium-term fiscal framework.

But it’s the rupiah that will become the most visible barometer of credibility for investors. Carry trades remain attractive, but without clear fiscal signals, exposure carries higher risk.

The bond curve could steepen if investors expect larger deficits or more issuance. Sovereign spreads may widen until markets are reassured that fiscal rules will hold.

Structural engines still matter

Indonesia’s long-term appeal has not disappeared. Downstreaming in nickel and batteries continues to attract foreign direct investment, though global disputes and ESG concerns highlight its fragility.

The planned new capital, Nusantara, has secured around 4 billion dollars of private commitments. Execution, however, remains slow, and the fiscal burden could crowd out other priorities if costs escalate.

Demographics and housing demand add momentum, but they rely on steady governance and disciplined financing.

Investors weighing long-term exposure to manufacturing or infrastructure will still find opportunities. The key is to demand contracts with ESG credibility and protections against policy shifts. Without fiscal discipline, even strong sectors risk contagion from broader market volatility.

What to watch next

The first official fiscal briefing from Purbaya will set the tone. Some indicators will be more closely watched than others.

For example, investors will look for detailed funding plans that keep the 2026 deficit near 2.5%. Budget debates later this year will reveal whether the government sticks to the deficit rule or seeks ways around it. Data on the meals program’s disbursement will show whether execution capacity is improving.

Bank Indonesia’s policy meetings will indicate whether fiscal pressures are feeding into monetary strategy. Current account releases will show how external buffers hold up as imports rise.

Each of these milestones carries market triggers. A credible funding plan could tighten spreads and stabilize the rupiah. Signs of rule-bending could fuel capital flight. The path forward will be determined less by declarations of 8% growth and more by the numbers in the budget tables.

In the words of the new finance minister:

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