Key Points
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Israel and the US jointly launched military action against Iran on 28 February, triggering a sharp risk‑off mood in global markets. Brent crude prices jumped on fears of supply disruption, while the US dollar strengthened and emerging market currencies, including the Indonesian rupiah, came under renewed downward pressure. The risk of a sustained oil price shock has risen materially. Iran has reportedly warned that oil tankers may not be allowed to transit the Strait of Hormuz, raising the prospect of major disruption to global oil supply.
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We expect the rupiah to weaken to 17,000 against the US dollar, with risks skewed to more downsides. Indonesia’s 5‑year CDS has moved above 80bps, while global equity volatility has risen, both pointing to a higher risk premium being priced into Indonesian assets.
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Higher oil prices introduce renewed inflation risks, partially offset by government subsidies. The administered RON90 (Pertalite) price has been fixed at IDR10,000 per litre since September 2022, when crude was trading around USD85–90/bbl then. Notably, despite the subsequent decline in global oil prices, domestic retail fuel prices were not adjusted lower, which helped contain fuel subsidy costs. With Brent prices currently still below levels seen during the Russia–Ukraine war, the scope for changes in administered fuel prices therefore remains contained for now. As such, we expect little additional contribution from administered price inflation to headline CPI.
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While February headline CPI inflation rose to 4.76%yoy, this largely reflects low base effects related to household electricity subsidies a year ago, which pushed down administered price inflation. To be sure, underlying inflation dynamics remain relatively contained for now, with core (+2.5%yoy) inflation relatively stable.
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Second round inflation effects are the key risks. While direct fuel price passthrough is likely limited, second‑round effects from higher oil prices, such as via shipping, logistics, and food costs, pose a more meaningful inflation risk. We estimate that every US$10 increase in Brent crude adds around 0.4pp to Indonesia’s headline CPI. If oil prices were to spike to USD100/bbl, from around US$60/bbl at end‑2025, Indonesia’s headline inflation could rise toward ~4.5%. This would still be below the 6.1% peak seen during the Russia–Ukraine shock, mainly reflecting our expectation of limited adjustment to administered fuel prices. Nevertheless, higher inflation would remain a drag on the rupiah, especially as the government appears willing to run the economy somewhat hotter, with a narrowing output gap skewing inflation risks to the upside.
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Trade balance deterioration adds to FX vulnerability. Beyond inflation, higher oil prices also worsen Indonesia’s external balance. We estimate that every USD10 increase in oil prices reduces Indonesia’s trade balance by ~0.2% of GDP, assuming relatively sticky oil demand. Under a sustained USD100/bbl scenario, the trade balance could deteriorate by around 0.8% of GDP. This represents a clear downside risk for the rupiah. For reference, USDIDR rose by around 3.5% from the start of the Russia–Ukraine war on 24 February 2022 to end‑H1 2022. In a comparable oil shock scenario today, we see scope for USDIDR to break above 17,000 and potentially move toward the 17,400 area.
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Bank Indonesia will likely keep rates on hold this month as the US-Iran conflict persists. The current BI policy stance remains modestly restrictive, which appears appropriate given rising external and currency pressures. But we retain our outlook for BI to cut rate in Q2, possibly in June, as our US strategists still expect a couple of US rate cuts in Q2.
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Beyond global factors, markets have priced in a negative policy risk premium into the rupiah. This reflects MSCI’s concerns around equity market investability, alongside Moody’s negative outlook on Indonesia’s sovereign credit rating. Fiscal dynamics have added to investor caution. Government spending surged 25.7%yoy in January, significantly outpacing revenue growth of 9.8%yoy, widening the budget deficit to IDR54.6tn, from IDR23.5tn a year earlier.
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Local market sentiment has weakened in tandem. Three‑month onshore forward points have risen to converge with offshore pricing, reducing the cost advantage of hedging USDIDR exposure onshore. Meanwhile, Indonesia has seen persistent net foreign bond outflows since mid‑February, with government bonds continuing to sell off. We see scope for yields to drift higher toward 6.6–6.8% in the near term. In our view, local bonds remain overvalued relative to rising fiscal risks, and could reprice more abruptly amid ongoing global uncertainty stemming from the US–Iran conflict.
