Bank Indonesia is grappling with mounting pressure to increase interest rates. It's a tense moment as the nation faces possible market downgrades and a weakening currency. The global index provider MSCI recently considered downgrading Indonesia's stock market from its emerging-market status. This announcement triggered a significant sell-off in stocks and a decline in the rupiah.
Economists are now revising their predictions in response. Citibank has shifted its stance, now forecasting a pre-emptive 50 basis-point rate hike to 6.25%, abandoning its previous expectation of no change. Meanwhile, Capital Economics and Permata Bank foresee a more modest 25 basis-point increase to 6%. The central bank has held its benchmark seven-day reverse repurchase rate steady at 5.75% since June.
The MSCI announcement last Friday suggested moving Indonesia to a "standalone" market status. This led to the worst two-day sell-off in the Jakarta Composite Index. However, the index rebounded by about 3% on Tuesday after authorities took steps to enhance market transparency, such as removing tightly held companies from the flagship index.
Despite these efforts, the rupiah weakened to 18,030 per dollar on Tuesday. This is near its record low from June and marks an 8% decline this year. Jason Tuvey, deputy chief emerging markets economist at Capital Economics, warned that not raising rates on Wednesday could disappoint investors and put more downward pressure on the currency. He also noted that maintaining current rates might raise concerns about political influence over the central bank's decisions.
Helmi Arman from Citi suggested that a rate hike could prevent equity outflows from affecting bonds and triggering capital flight by domestic investors. He described the potential rate increase as a "one-off" measure, to be followed by other support mechanisms like government foreign-currency borrowing or additional bilateral currency swaps with foreign central banks.
Bank Indonesia has already raised rates by a total of 100 basis points since May. Headline inflation hit a three-month high of 3.28% in September, within the target range of 1.5%-3.5%, while core inflation eased to 2.84%. The central bank's governor, Destry Damayanti, expressed confidence that the country's foreign-exchange reserves, which stood at $146.3 billion at the end of September, would be sufficient to stabilize the rupiah.
Josua Pardede, chief economist at PT Bank Permata, highlighted the risk of foreign equity withdrawals further weakening the rupiah and triggering a sell-off in government bonds. He estimated that foreign investors have net sold approximately $5 billion of Indonesian stocks this year. Pardede emphasized that the most significant risk is not merely losing emerging-market status but allowing doubts about market integrity to lead to a lasting increase in Indonesia's cost of capital.
An MSCI downgrade could result in $3 billion to $5 billion of passive outflows. Additionally, $15 billion of actively managed foreign investments could be reassessed, according to Pardede. He anticipates that the market adjustment could occur in stages, with precautionary selling through the first half of 2027 and mechanical selling if MSCI confirms the downgrade by June.
Pardede called for credible market-governance reforms, including reliable free-float data, ownership disclosure, and transparent engagement with international institutional investors, to address MSCI's fundamental concerns. He stressed that while Bank Indonesia can provide liquidity and reduce excessive volatility, only substantial reforms can restore market confidence.
