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Bank Indonesia is likely to extend its pause on rates in a bid to safeguard rate sensitive flows and keep currency weakness in check, with an eye on Middle East tensions. An extended conflict will introduce inflationary pressures via retail fuel price adjustments (if subsidies are reduced), higher costs of industrial raw materials, transportation, and derivative products, besides second order effects. As it stands, Feb inflation had jumped to 4.8% yoy from 3.5% month before, due to base effects. Fading impact of one-off stimulus measures implemented in 1Q25 was evident in the administered price component, which had contracted sharply by 9% yoy a year earlier and was up 13% in Feb26. Pipeline inflationary pressures and an effort to preserve policy space are likely to keep benchmark rates unchanged in March.
Fiscal risks have returned to the fore amidst indications that that the deficit target might be temporarily breached on emergency grounds to accommodate higher-than-budgeted oil prices and resultant increase in subsidies. Officials had reportedly discussed a few revised assumptions to incorporate the impact of the Middle East war (ICP at $70bp in 2026 budget). The fiscal deficit was already at risk of widening prior to the escalation of tensions in the Middle East (outlook revision by Fitch), given a strong jump in spending in Jan-Feb26 and pre-commitments to large social sector programs this year. Markets remain unconvinced that the first official response should be to test the mandated threshold instead of spending rationalisation.
IDR remained under pressure on a bid DXY and broader risk aversion, equities corrected sharply on Monday and 10Y yield raced towards 6.9%, with investors also trimming positions ahead of the long onshore Eid holiday. On Monday, officials assured that spending cuts amongst various ministries and programs might be the first port of call to stay within the mandated deficit cap, but commitment towards flagship schemes like the free meals and support for village cooperatives will remain in place. Windfall taxes from rising key commodities might also be on the anvil. Further details are awaited when markets return from the break, in absence of which market underperformance is likely to continue.
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