The Liquidity Problem Behind Indonesia’s Easing Path
Bank Indonesia will probably continue to ease policy but slowly
Bank Indonesia (BI) unsurprisingly held rates at the latest meeting to keep the BI rate at 5.50%. This was largely due to the uncertainty in trade and tariffs. However, these uncertainties will likely persist for at least another quarter as trade negotiations do not seem to be progressing. If so, does that mean that BI will hold rates until all uncertainty is cleared? Probably not.
In this article, I will lay out what I think the BI rate easing path would be and what the concerns of the BI are.
In short, as my note earlier this month explained, USDIDR at the 16,000-16,450 is probably an acceptable range for the BI. This means that as the Iran-Israel conflict subsides, falling risk premiums would lead the USDIDR back to this range. Fundamentals will be the focus from now on.
However, the "fundamentals” of BI are not just the growth-inflation dynamic, but also banking and liquidity stability. Monetary policy transmission in Indonesia is less direct and more uncertain due to the myriad of policy tools. As such, while the bias will be tilted towards easing, banking stability will guide the timing and decisions on non-interest rate monetary policy.
Growth is a bigger concern than inflation
Indonesia, like most ASEAN economies, have been facing a slowing economy but stable inflation, which points towards monetary policy easing.
1Q25 GDP rose just 4.87% y/y, a far cry from the Prabowo administration's target of 8% and the generally expected annual 5% growth. This is even before the tariff was implemented.
Higher frequency data have also pointed to a marked slowing of activity.
Credit growth has slowed in 2025, and the trend seems to be continuing in Apr 25.
Since BI has been on an easing pathway, the falling credit growth reflects softer business and investor confidence.
Industrial production has been on a downtrend since 4Q24, as commodity prices soften.
The Nickel market is painfully oversupplied, and Indonesia is facing the consequence of its Nickel refining push under Jokowi’s administration.
On the other hand, its oil and gas sector has been declining as existing oil reserves get depleted and its productivity falls.
The forward-looking Purchasing Managers’ Index (PMI) is also flashing warning signs.
The manufacturing PMI has made an about-turn in Mar 25, as producers report a slowing of activity and increased risk aversion.
By all accounts, Indonesia’s growth is slowing
Inflation has also been soft, with headline and core coming in at 1.60% and 2.4% respectively.
It is firmly within the BI’s 2025 target range of 1.5-3.5%.
Outside of subsidy rationalisation and administered price hikes, few catalysts could spur an inflationary cycle.
In fact, with the US-China trade tensions mounting, the risk is tilted to the downside as Chinese trade diversion may flood Indonesia’s domestic markets with Chinese goods.
Typically, this should mean that calculus is simple, and BI should cut rates. However, this low-growth-low-inflation dynamic is unfortunately followed by poor market liquidity. So, the BI will likely still cut, but slowly.
Low liquidity is a constraint
Liquidity in Indonesia has been tight for a while, likely since June 24 when the overnight interbank IndONIA rate rose above the BI rate. Much of this has to do with the massive issuance of the Bank Indonesia Rupiah Securities (SRBI).
The SRBI is an instrument issued by BI to attract international flows.
Its yield at issuance is above the BI rate and IndoGBs with the same tenor.
This allows BI to raise the yield differentials without raising the BI Rate.
This means that the BI has a more refined tool to address IDR weakness without slowing the entire economy through policy tightening.
However, an unintended consequence is that domestic players are also interested in holding these instruments. After all, if banks are holding extra cash, why get a lower rate in the interbank market when you can reap higher risk-free rates in 3m SRBI.
This is a concern as the interbank market is meant to spread liquidity around; banks with more cash can lend to cash-strapped banks to fulfil overnight financing needs. A spike in SRBI issuance in 2Q24 saw onshore banks shunning this interbank market.
Due to the surge in issuance in 2H24, there is a sizable amount of SRBI and IndoGBs poised for maturity. The maturity wall of SRBI alone within the next two months will amount to IDR367tn. Where the foreign holders of SRBI go after this is uncertain, but it has significant implications for the IDR and liquidity in Indonesia.
I am worried about this potential outflow of foreign funds due to the fundamentals of the USDIDR pair. In general, the pair is greatly influenced by the aggregate balance, USD strength, and global risk sentiment. Yield differentials often influence the aggregate balance of the Indonesian economy.
The influence of the aggregate balance (Savings minus Investment, in BOP CA = S-I) on USDIDR is rather straightforward.
If investments outpace savings (S < I), it implies that credit growth is being fueled by foreign capital.
The market typically punishes EM Asian economies for this, viewing them as structurally dependent on external financing and thus vulnerable to global volatility.
From a balance of payments perspective, S < I implies a CA deficit.
This requires sustained capital inflows to fund, a vulnerability that can translate into currency depreciation when market sentiment sours.
For this article, aggregate balance is the foreign ownership of SRBIs added to Net Bank Balance (the total savings minus investments of domestic agents).
Since 2017, the IDR have cycled through the three main causes of IDR depreciation. It appears that we are in another deteriorating aggregate balance cycle, which coincides with the taper of foreign ownership of SRBI.
The taper is due to the negative net issuance of SRBIs as BI shuns the instrument that has bolstered domestic savings since 2023. Since BI began allowing SRBIs to mature without rolling them over, foreign owners have opted to enter the onshore IndoGB market (SBN)
Short-tenor SBN is a good substitute for SRBIs, as the government backs both; however, the SBN has lower liquidity and offers yields closer to the BI Rate. This means that if BI Rates get cut aggressively, the appeal of SBN falls, which would spur quick fund outflows. In short, the SRBI was effective in attracting inflows, but as BI cut back on issuances, the SBN has a greater responsibility in keeping these flows onshore.
Why taper SRBI issuances?
Since 3Q24, Indonesia’s interbank market has been flashing warning signs of a liquidity issue. As cash-rich onshore banks opt to hold SRBI instead of lending in the interbank market, the overnight IndONIA have persistently traded above the BI-Rate. Although this does not signal a pending liquidity trap, it does point to some liquidity tightness.
The liquidity issue became more prominent in the Idul Fitri rush for cash, where the IndONIA rate spiked above the Lending Facility rate. It signals that banks were unprepared for this seasonal demand for cash, and the interbank market was insufficient to provide cash on demand.
Furthermore, after the May 25 rate cut, the IndONIA did not follow the BI Rate and kept trading at the pre-cut levels. It took the seasonal Idul Adha cash injection to push the IndONIA back down.
The decision to slowly taper SRBI net issuances (Volume of SRBI Issances minus SRBI maturing) is a clear sign that BI is prioritising liquidity and financial stability over supporting the USDIDR. Of course, this means that other instruments will be used to support the IDR.
In response to the tightening liquidity, BI has injected cash through its Repo facility. So far, BI has been rather gun-shy, opting for measured injections as they taper SRBI issuances. However, onshore banks are still not utilising BI facilities to the same level as the pre-SRBI era.
Typically, such illiquidity would lead market rates to rise as banks and NBFIs compete for deposits. Institutions that rely on savings to conduct business would normally bid up interest rates to attract inflows. However, they are reluctant to do so while BI is in a monetary loosening cycle. Raising rates offered would be imprudent as it increases funding costs just as the broader investment rate environment is expected to soften.
The BI broadly have three solutions to this dilemma.
Stop cutting rates entirely and let SRBI pressure ease
Increase injections via the repo facility
Cut rates slowly
The likely choice will be a combination of options 2 and 3. However, we should be aware that option 3 is a bet that the USD will continue to weaken.
Since IDR stability is a stated goal of the BI, rate decisions are often reliant on the USDIDR outlook. If BI cuts at the same pace and timing as the US Fed, the move is effectively neutral. Yield differentials are preserved, aggregate balance is roughly unchanged.
Therefore, the USDIDR pathway will largely be driven by the USD itself and shifts in risk sentiment. Since forecasting risk sentiment is inherently unreliable, cutting in lockstep with the US Fed is effectively an expression of the view that the USD will weaken
Betting on a weaker USD for the rest of the year is understandable, in fact, it is the consensus pick now. So, engaging in a slow rate cut pathway is expected, although a sudden bout of USD strengthening might change this outlook.
BI Mandate and its policy choices
This article attempts to analyse BI’s monetary policy decisions through the price stability, sustainable growth, and financial stability mandates. Whereby price stability is achieved through a stable IDR and low inflation.
If you look through the lens of the price stability and sustainable growth mandate, it seems that policy easing is an easy decision. However, the financial stability mandate is where we run into some problems with a deeper cut pathway.
As seen from the BI’s SRBI issuance taper and the expansion of the repo facility, liquidity conditions are now in focus for the BI.
Restoring liquidity can only be achieved through increased contributions from three sources.
More savings from corporations and households
BI liquidity injections (Increased use of the repo facility)
Foreign inflows
For sources 1 and 3, having the BI Rate stay higher is probably the solution. Private savings would be supported if banks offered higher deposit rates, which are based on the benchmark rate. Without increased SRBI net issuances, foreign inflows will primarily look for IndoGBs, especially for carry trades.
Cutting quicker than funding currencies and other EM economies will reduce the appeal of IDR assets since it weighs on IndoGB yields. This also raises FX risks, as investors typically enter unhedged and may face losses if the IDR weakens.
Another burgeoning threat to IDR stability is the Japanese and US fiscal pathway. Japan has tweaked its issuance mix to increase the supply of short-term JGBs. Meanwhile, the US has stuck to its short-tenor bond issuance mix and deep deficit spending. As such, the supply of short-tenor JGB and UST will likely rise through the year.
The BI might have to consider this when deciding policy, as cutting too deeply may push foreign investors to enter the more trusted JGB or UST market. The SRBI was enough to address this issue, but as BI retreats from this tool, Indonesia is more exposed to foreign outflow risks.
Conclusion
My baseline expectation is two 25bps cuts to BI Rate in 2025, with the BI cutting once per quarter. This is, of course, quite close to the market view. But my overall argument is that the BI Rate decision is not as clear as it seems. BI is undoubtedly maintaining its easing bias, but the liquidity issue is the main constraint that inhibits this pathway.
My baseline view is subject to some risks. But I see all possible BI Rate pathways depending on the fulfilment of four conditions.
Inflation remains low (Expected to persist)
Growth remains anaemic (Expected to persist)
USDIDR is stable or gradually appreciating (Uncertain)
Liquidity is restored, or on the path to restoration (Uncertain)
The most recent meeting saw conditions 1 and 2 fulfilled, but not 3 and 4. Looking ahead, I believe the real challenge will be condition 4. Condition 3 is not expected to be a hurdle, but it could still surprise on the back of unexpected developments such as favourable US trade deals or a global risk-off episode unrelated to the US.