Lessons from Indonesia: From populist policies to an economic time bomb

These signals may point to deeper structural issues in the country’s economic and political landscape.

Bhima Yudhistira Adhinegara, Director of the Jakarta-based Center of Economic and Law Studies, warns that the rupiah’s depreciation reflects market distrust toward President Prabowo Subianto’s leadership and economic policies, including the establishment of the Danantara sovereign wealth fund.

Prabowo’s Policies Put Fiscal Pressure on Indonesia

Indonesia was once a top investment destination in the region, but last year, it lost its appeal among global investors at an alarming rate. Under President Prabowo Subianto, the government has made steep budget cuts across critical sectors, such as higher education funding slashed by 39%, healthcare spending reduced by 18.5% and public infrastructure projects cut by a staggering 73%

As the global economy slows down, these cuts are not seen as strategic adjustments but rather as confidence-shaking measures that erode public trust, heighten economic concerns, and trigger capital outflows from Indonesia.

President Prabowo’s “populist” policies have become an increasing concern regarding economic policy stability. His universal free school lunch program, expected to cost a massive 950 billion baht per year, risks pushing Indonesia’s budget deficit beyond the legally mandated 3% of GDP.

In February, Indonesia established Danantara Indonesia, a sovereign wealth fund consolidating several state-owned enterprises, and announced its advisory board members, including former Thai Prime Minister Thaksin Shinawatra, billionaire Ray Dalio, and investor Chapman Taylor.

Initially seen as an ambitious move, the Danantara fund is now being regarded as a potential “financial time bomb” that could destabilize the economy. Critics have raised concerns over its management and transparency, suggesting that investment decisions might be driven more by political than economic factors.

With rising budgetary demands from both Danantara and Prabowo’s populist policies, Indonesia may face increased fiscal burdens, including a widening budget deficit.

Prabowo’s Policies Put Fiscal Pressure

Indonesia was once one of the most attractive markets in the region, but last year, it rapidly lost its appeal among global investors. President Prabowo’s administration has made deep budget cuts across essential sectors, slashing higher education funding by 39%, healthcare spending by 18.5%, and public infrastructure and utilities projects by 73%.

At a time when the global economy is facing a slowdown, these spending cuts are not seen as a sound strategy. Instead, they have eroded public confidence, heightened economic concerns, and triggered capital flight, with investors pulling out of the country.

One of the biggest concerns regarding economic policy stability is Prabowo’s populist initiatives, particularly the free lunch program, which is expected to cost a staggering 950 billion baht per year. This expenditure risks pushing Indonesia’s budget deficit beyond the 3% of GDP cap mandated by law.

In February, Indonesia established Danantara Indonesia, a sovereign wealth fund consolidating multiple state-owned enterprises. The government also unveiled an advisory board comprising former Thai Prime Minister Thaksin Shinawatra, billionaire Ray Dalio, and investor Chapman Taylor.

Initially seen as an ambitious initiative, the Danantara fund is now regarded as a potential “financial time bomb” that could destabilize the economy. Critics have raised concerns over its management and transparency, suggesting that investment decisions may be influenced more by political motives than economic rationale.

With both Danantara and Prabowo’s populist policies placing immense pressure on fiscal resources, Indonesia faces an increasing risk of a widening budget deficit and mounting financial burdens.

Investor Confidence in Indonesia Declines

The impact of these factors has become increasingly evident as foreign investors continue to withdraw their capital. On March 18, the Jakarta Stock Exchange Composite Index (JCI) plummeted by 7.1%, marking its steepest drop in 14 years. Trading had to be halted for the first time, and the index has fallen over 12% this year. Meanwhile, global funds have offloaded more than $2 billion worth of Indonesian stocks in 2024.

Adding to the turmoil, the Indonesian rupiah depreciated to IDR 16,642 per US$, its lowest level in 27 years, dating back to the 1998 financial crisis. The currency has weakened by over 3% this year, making it one of the worst-performing emerging market currencies in 2024.

Pressure on the rupiah intensified in January after Bank Indonesia (BI) unexpectedly cut interest rates by 0.25% to 5.75%, contrary to economists’ expectations of a rate hold. BI stated that the move was aimed at stimulating economic growth, even though it further weakened the currency. As a result, the rupiah fell to record lows, forcing BI to intervene almost daily to stabilize the exchange rate.

Lloyd Chan, a currency strategist at MUFG, noted that markets are increasingly concerned about the Indonesian government’s rising expenditures on social programs under the new administration. This cautious investor sentiment could lead to further depreciation, with the rupiah potentially breaching IDR 17,000 per US$ if US President Donald Trump moves forward with tariff hikes next week.

Asia Times reported that as capital continues to flow out of Indonesia, the rupiah becomes more vulnerable to external shocks. A weaker rupiah means higher import costs, rising inflation, and greater difficulty in servicing foreign debt.

Multiple Factors Weigh on Indonesia’s Economy

The Indonesian rupiah’s recent depreciation is not driven by a single cause but rather a mix of external and domestic factors.

One major external factor is Indonesia’s widening current account deficit, exacerbated by uncertainties in exports due to US trade policies under President Trump. These concerns may escalate further on April 2, when potential tariff adjustments could come into effect.

On the domestic front, investors are increasingly worried about Indonesia’s fiscal deficit, political instability following changes in military-related laws, and uncertainty surrounding the position of Finance Minister Sri Mulyani Indrawati, a key figure in maintaining economic stability.

All of this is happening amid a domestic economic slowdown, characterized by weaker consumer spending and declining confidence. These vulnerabilities have heightened investor concerns over Indonesia’s future growth prospects.

Indonesia’s Economy Remains Resilient

Despite concerns over the rupiah’s depreciation, BI reassures markets that the current situation is not comparable to the 1998 financial crisis.

Airlangga Hartarto, Coordinating Minister for Economic Affairs, remains confident that the rupiah’s weakness is temporary, citing Indonesia’s strong economic fundamentals. He highlighted a stable economic foundation, a recovering market, and positive sentiment from shareholder meetings of state-owned banks Bank Rakyat Indonesia and Bank Mandiri, both of which are listed on the stock exchange.