Indonesia’s slow-motion loss of macro credibility

Indonesia is not on the brink of another Asian Financial Crisis. Its banks are stronger, public debt remains moderate, foreign-exchange reserves are far larger, and the exchange rate is flexible. Yet recent market signals are difficult to ignore: the rupiah has fallen to record lows, Jakarta stocks have suffered heavy losses and foreign outflows, and investor confidence has weakened. Indonesia is not being punished because it is fragile in the old sense. It is being repriced because markets are beginning to question the reliability of its macroeconomic policy framework.

Two recent policy signals help explain why. The first is fiscal. Large spending commitments, energy subsidies, food programmes, quasi-fiscal initiatives, and more interventionist control over strategic commodity exports have raise doubts about whether the government still treats predictability and fiscal discipline as binding constraints. The new arrangement involving Danantara Sumberdaya Indonesia, which centralises key commodity exports through a state-linked entity, may be justified as an effort to raise revenue and reduce under-invoicing. But without clear rules, it risks reinforcing the perception that policy can change abruptly and that private contracts are increasingly subordinate to state direction.

The second signal is institutional. The amendments to the financial-sector law expand Bank Indonesia’s mandate beyond price and exchange-rate stability to include real-sector growth and job creation, while giving parliament greater powers to evaluate the central bank and revise mechanisms for removing its board. This is not a minor technical adjustment. In an emerging market with a history of currency instability, even the perception that monetary policy may be pulled closer to short-term political growth objectives can raise the risk premium on the rupiah. 

For much of the post-1998 period, Indonesia’s comparative advantage among emerging markets was not spectacular growth. It was credibility. Investors accepted Indonesia’s structural weaknesses—low tax collection, infrastructure gaps, regulatory uncertainty, dependence on commodities—because these were balanced by prudent fiscal management, a respected central bank, and a broadly orthodox macroeconomic framework. That credibility allowed Indonesia to borrow at reasonable cost, attract portfolio inflows, and avoid the repeated crises that afflicted many other emerging economies. That advantage is now at risk. 

The government is right to want faster growth. Indonesia cannot be satisfied with 5% forever. A young labour force, large domestic market, and continuing infrastructure needs justify ambition. But ambition is not a substitute for credibility. Growth targets do not become credible because they are announced. They become credible when investors believe the state can fund them sustainably, implement them predictably, and preserve the institutions that anchor macroeconomic stability.

The fiscal concern is not that Indonesia’s debt is already excessive. Compared with many emerging markets, it is still manageable. The problem is direction and discipline. Indonesia’s revenue base remains thin, which allows less room for large permanent programmes unless the government raises revenue, cuts other spending, accepts higher deficits, or shifts costs off budget. The last option is especially risky. Off-budget spending may obscure the fiscal burden temporarily, but markets usually find it eventually.

Monetary credibility is equally important. Bank Indonesia’s independence has been one of the pillars of post-crisis macroeconomic management. It helped convince investors that inflation would not be sacrificed for short-term political growth objectives and that the rupiah would not be defended through incoherent policy. Any perception that the central bank is being drawn closer to the government’s growth agenda, or exposed to political pressure, weakens that anchor.

This does not mean central banks should ignore growth and employment. No central bank operates in a social vacuum. But there is a difference between recognising the real economy and diluting the hierarchy of objectives. In an emerging market with a history of a currency instability, monetary credibility is hard to build and easy to lose. Once markets believe the central bank may be pressured to accommodate fiscal expansion, the currency risk premium rises.

The government may argue that Indonesia’s recent market pressure reflects external shocks: a strong US dollar, higher oil prices, geopolitical tensions, and risk aversion toward emerging markets. These factors are real. But they are not sufficient explanations. Other countries face the same global environment. What matters is why Indonesia has been punished more severely than many of its peers. The answer lies not only in macroeconomic numbers, but in doubts about policy direction, institutional safeguards, and fiscal governance.

Indonesia is still not Thailand in 1997. It is not Turkey with runaway inflation. It is not Argentina with chronic default risk. But that is a low bar. The relevant comparison is with Indonesia’s own hard-won reputation. The country spent more than two decades convincing markets that it had learned the lessons of crisis: keep deficits under control, protect the central bank, managed debt prudently, and avoid sudden policy experiments that unsettle investors.

The irony is that Indonesia’s current strengths make the policy slippage less excusable. This is not a country forced into desperation by overwhelming debt or collapsing growth. It is a country with moderate debt, contained inflation, a large domestic market, and still-respectable growth. That gives policymakers room to act carefully. Instead, recent signals have created the impression of impatience: impatience with fiscal constraints, impatient with institutional independence, and impatience with the slow work of structural reform. 

If the government wants 8% growth, the answer is not to pressure the central bank or stretch the budget. It is to raise productivity: improve the tax system, reduce regulatory uncertainty, deepen competition, invest in human capital, make industrial policy more transparent, and attract investment through predictability rather than discretion. Credibility is not anti-growth. It is the foundation of sustainable growth.

Indonesia does not need panic. But it does need course correction. The government should reaffirm the fiscal rules, publish credible medium-term financing plans for major programmes, avoid quasi-fiscal opacity, and protect Bank Indonesia’s operational independence. These steps would not solve all structural problems, but they would send a clear signal that Indonesia still values the macro discipline that made it stand out.

The problem today is not crisis. It is complacency. Indonesia’s comparative strength has long been that, despite its imperfections, investors trusted its macro framework. If that trust continues to erode, Indonesia may discover that credibility, once lost, is far more expensive to rebuild than to preserve.

Arianto A. Patunru is a Fellow of ANU Indonesia Project, Arndt-Corden Department of Economics, Australian National University.