Middle East war, a weak currency, and populism: Indonesia’s emerging-market status is under strain

【Financial News Hanoi, Vietnam = Kim Joon-seok】 Indonesia’s capital market is facing an unprecedented threat of losing its emerging-market status, as global index providers have issued a series of warnings that it could be downgraded to frontier market status. After MSCI postponed its downgrade review until November on May 23, S&P Dow Jones Indices (DJI) placed Indonesia on watch for a frontier market downgrade on June 7, citing the opacity of its market structure. Moody’s Corporation and Fitch Ratings also cut their outlooks on the country’s sovereign credit rating to negative in February and March, respectively, citing concerns over the Prabowo Subianto administration’s fiscal expansion.
As concerns grow over capital outflows, analysts say surging oil prices triggered by Iran’s blockade threat in the Strait of Hormuz, along with the Prabowo administration’s populist fiscal policies, are deepening market instability.
■ Rupiah and stocks plunge together, trapping markets in a vicious cycle
According to local media on the 19th, the Indonesian rupiah closed at 17,921 per dollar on the 17th, while the Jakarta Composite Index (JCI) ended at 6,175.54, down 28.58% from its year-to-date peak. Although the JCI has rebounded for seven straight trading sessions, its annual return remains among the world’s worst. The rupiah also briefly fell to a record low of 18,200 per dollar.
Market participants say the spike in oil prices has widened the fiscal deficit by increasing the burden of energy subsidies. To cover the gap, the government has issued more bonds, which has pushed up interest rates and triggered foreign capital outflows. As dollar demand rose, the rupiah weakened sharply. Stocks also fell as companies dependent on imported raw materials faced higher costs and growing concerns over foreign-exchange losses.
As a net oil importer, Indonesia has rapidly exhausted this year’s 22 billion dollars in energy subsidy allocations because of the Strait of Hormuz fallout. Foreign media reported that the government may need at least another 6 billion dollars in fiscal resources.
■ Growing concerns over populist spending, including free school meals
Another factor fueling market anxiety is President Prabowo’s large-scale welfare pledges. During the presidential campaign, he promised to expand spending on housing, education, and healthcare, while also aiming for 8% economic growth during his term. After taking office, he launched a 90 billion dollar SWF.
His flagship free school meal program received 171 trillion rupiah in funding last year, and the government plans to nearly double that amount this year. However, a lack of meal-service infrastructure meant that the number of beneficiaries had reached only about 4 million by midyear, far below the target of 17 million. The program also drew criticism after food poisoning incidents and corruption allegations.
In March, President Prabowo reduced the number of meal-service days from six to five per week. Then on the 15th, he ordered officials to exclude groups that do not truly need the meals, shifting the policy toward more targeted support.
Rizal Sidhak, an economics professor at Leiden University in the Netherlands, told Deutsche Welle (DW) that "core welfare programs are already straining limited fiscal room, and the Strait of Hormuz crisis has further weakened sustainability."
According to CEIC, Indonesia’s government debt ratio is relatively low at 40.75% of GDP, but about 25% of this year’s government revenue is expected to go toward interest payments on government debt. That is more than twice the level recommended by the International Monetary Fund (IMF). The amount of government debt due for refinancing this year also reaches 834 trillion rupiah.
■ "A downgrade to frontier market status would trigger massive capital outflows"
S&P Global Ratings kept Indonesia’s sovereign credit rating at BBB with a stable outlook on the 13th, but Moody’s Corporation and Fitch Ratings have maintained their negative outlooks. Meanwhile, MSCI and S&P DJI have raised concerns over listed companies’ shareholding structures and market accessibility, further dampening foreign investor sentiment. If a downgrade to frontier market status becomes reality, large-scale withdrawals by global institutional investors are widely expected.
Professor Rizal Sidhak said, "At a time when capital raising is urgently needed, this could push Indonesia out of the global investment landscape."
Siewage Dharma Negara, a senior researcher at the ISEAS-Yusof Ishak Institute in Singapore, warned that "when fiscal risks and currency weakness combine, investor confidence can collapse quickly." Arianto Patunru, a researcher at Australian National University (ANU), also said that "if the government continues to expand spending, the economy could move beyond a mild slowdown and enter a sharp downturn."
rejune1112@fnnews.com Kim Joon-seok Reporter