Indonesia Economy Watch: Week 3, June 2025 - Navigating Soaring Inflation and Shifting Trade Dynamics

Rising global oil prices, reaching $73.56 per barrel in June 2025, have increased import costs, posing potential risks to inflation. Meanwhile, domestic demand remains robust, fueled by government

Welcome to our in-depth analysis of Indonesia’s economic landscape as we approach the second half of 2025. This newsletter explores the central theme of inflationary pressures and their implications for Indonesia’s economy over the next 12 months. With a robust growth trajectory and a resilient economic framework, Indonesia faces both opportunities and challenges in maintaining stability amid global uncertainties and domestic dynamics. We delve into the factors shaping inflation, the policy responses, and their broader impact on households, businesses, and financial markets, while offering projections and strategic insights for stakeholders.

A Resilient Economic Foundation

Indonesia’s economy has demonstrated remarkable resilience, achieving a growth rate of 4.95 percent year-on-year in the third quarter of 2024, outperforming several ASEAN peers such as Thailand and South Korea. Projections for 2025 estimate growth at 5.2 percent, driven by strong domestic demand and structural reforms. Inflation, a critical indicator, stood at a manageable 1.60 percent in May 2025, down from 1.95 percent in April, reflecting effective monetary and fiscal policies. Bank Indonesia’s prudent approach, maintaining the benchmark interest rate at 6.00 percent, has balanced growth with price stability, while a strengthening rupiah and steady credit growth further bolster economic confidence.

The past week has seen notable developments. Rising global oil prices, reaching $73.56 per barrel in June 2025, have increased import costs, posing potential risks to inflation. Meanwhile, domestic demand remains robust, fueled by government initiatives like the Harbolnas shopping festival and efforts to stabilize food prices. These dynamics set the stage for our exploration of inflationary pressures and their multifaceted impacts.

Defining and Understanding Inflationary Pressures

Inflation, defined as the sustained increase in the prices of goods and services, is driven by both structural factors, such as fiscal and monetary policies and import dependency, and cyclical factors, including global commodity prices and domestic demand. Over the next 12 months, Indonesia’s inflation is projected to range between 1.5 and 3.5 percent, influenced by global commodity volatility, domestic consumption patterns, and exchange rate movements. Bank Indonesia’s target of 2.5 percent plus or minus 1 percent provides a stable framework, but external and internal pressures warrant close attention.

Key Drivers of Inflation

Global Commodity Prices

Global commodity prices, particularly for oil and food, are a significant driver of inflation in Indonesia. The recent surge in crude oil prices to $73.56 per barrel, up 16.49 percent in a month, directly impacts the cost of imported energy, which filters into domestic prices for fuel and transportation. Food inflation, driven by staples like rice and cooking oil, remains a concern, with rice prices contributing 0.56 percent to month-on-month inflation in January 2025. Palm oil, a key export, reached 3,927 MYR per ton in June 2025, affecting both export revenues and domestic price dynamics. Volatility in these markets could push inflation toward the higher end of projections if global supply chains face further disruptions.

Monetary Policy

Bank Indonesia’s monetary policy is pivotal in managing inflation. The central bank’s decision to maintain the BI-Rate at 6.00 percent, following a 25-basis-point cut in September 2024, reflects a cautious approach to supporting growth while curbing price pressures. Tools like Securities of Bank Indonesia (SRBI), Islamic SRBI (SVBI), and Sharia-compliant SUVBI have stabilized the rupiah, mitigating inflationary risks from currency depreciation. This proactive stance is critical as global monetary tightening, such as potential rate hikes by the U.S. Federal Reserve, could trigger capital outflows and weaken the rupiah, exacerbating import-driven inflation.

Domestic Demand

Strong domestic demand, underpinned by a Consumer Confidence Index of 127.7 in December 2024 and an expansive Manufacturing PMI of 51.2, is a double-edged sword. Government programs, including discounts during Harbolnas and social protection initiatives, have bolstered consumption. However, if demand outpaces supply, particularly for food and energy, it could fuel inflationary pressures. The government’s focus on stabilizing staple prices and enhancing domestic production is crucial to maintaining this balance.

Fiscal Policy

Fiscal policy plays a significant role in shaping inflation. The 2025 Macroeconomic Framework and Fiscal Policy (KEM-PPKF) emphasizes inclusive and sustainable economic transformation through investments in digitalization, infrastructure, and social protection. While these initiatives drive growth, expansive government spending could stoke inflation if not matched by increased production. Subsidies for energy and food have historically dampened price increases, but any reduction to narrow the budget deficit could elevate costs for households and businesses.

Labor Market Dynamics

The labor market presents mixed signals. The open unemployment rate dropped to 4.76 percent in February 2025 from 4.82 percent a year earlier, indicating resilience. However, wage growth has lagged behind inflation, eroding purchasing power for many households. Automation and digitalization, while enhancing productivity, are reducing demand for low-skilled labor in certain sectors, limiting wage-driven inflation. This dynamic underscores the need for policies that support upskilling and maintain consumer spending power.

Geopolitical and Supply Chain Risks

Geopolitical tensions, such as U.S.-China trade disputes or disruptions in critical shipping routes like the Red Sea, pose risks to global supply chains. These could increase the cost of imported goods, particularly energy and raw materials, driving domestic inflation. Indonesia’s efforts to reduce import dependency through domestic production are promising but require sustained investment to fully mitigate these risks.

Projecting Inflation: Optimistic and Pessimistic Scenarios

Based on historical trends and current data, inflation is likely to remain within a manageable range over the next 12 months. In an optimistic scenario, inflation could stabilize between 1.5 and 2.5 percent, driven by stable global commodity prices and balanced domestic demand. Bank Indonesia’s tight monetary policy and continued subsidies would reinforce this outcome. In a pessimistic scenario, inflation could climb to 3.0 to 3.5 percent if oil prices exceed $80 per barrel, the rupiah depreciates significantly, or supply chain disruptions intensify. Strengthening domestic production and coordinating monetary and fiscal policies will be critical to avoiding this outcome.

Historically, Indonesia has maintained low inflation, achieving 1.57 percent in 2024 and 2.61 percent in 2023, among the lowest in two decades. This track record suggests a strong capacity to manage inflationary pressures through effective policy coordination.

Impacts Across Sectors

Household Consumption

Household consumption, a cornerstone of Indonesia’s GDP, faces challenges from rising inflation. Higher prices for essentials like food and fuel could erode purchasing power, particularly for low-income households. Government initiatives, such as food price stabilization and social assistance programs, are mitigating these pressures, but sustained inflation could shift consumption toward cheaper substitutes, altering demand patterns.

Retail and Industry

Retail and industrial sectors are adapting to inflationary pressures. Retailers may face margin squeezes as input costs rise, prompting price adjustments or promotional strategies to maintain sales. The manufacturing sector, with a PMI indicating expansion, must enhance efficiency to remain competitive. Businesses are likely to pass on some cost increases to consumers, potentially amplifying inflation if not carefully managed.

Financial Markets

Inflation influences financial markets, affecting bonds, equities, and the rupiah. Higher inflation could lead to tighter monetary policy, increasing bond yields and pressuring equity valuations. A weaker rupiah, driven by global rate hikes or capital outflows, would raise import costs, further fueling inflation. Investors are closely monitoring Bank Indonesia’s policy signals and global economic trends, with market sentiment hinging on the government’s ability to maintain stability.

Small and Medium Enterprises (SMEs)

SMEs, vital to Indonesia’s economy, are particularly vulnerable to inflation due to thin profit margins. Rising costs for raw materials and energy could erode competitiveness, but digitalization offers a lifeline. Government support through e-commerce platforms and targeted stimulus can help SMEs navigate these challenges, enhancing their resilience and market reach.

Comparative Insights from Emerging Markets

Indonesia’s experience with inflation can be contextualized by examining other emerging markets. Malaysia has effectively used fuel subsidies to curb inflation, a strategy Indonesia could refine to balance fiscal sustainability with price stability. India’s approach, combining tight monetary policy with food market interventions, offers lessons for managing staple prices. Brazil, grappling with higher inflation due to commodity export reliance, highlights the risks of over-dependence on global markets. Indonesia’s diversified economy and strong domestic demand provide a comparative advantage, but continued reforms are essential to sustain this edge.

The Risk of Stagflation

Stagflation, the combination of high inflation and economic stagnation, remains a concern if global commodity prices surge and growth falters. This scenario could strain employment and deter long-term investment. Mitigation strategies include maintaining flexible monetary policy, prioritizing productive government spending, and boosting domestic production to reduce import reliance. These measures can help sustain growth while keeping inflation in check.

Social and Political Implications

High inflation could erode public trust in economic institutions, particularly if essential goods become unaffordable. Perceptions of government effectiveness in managing inflation will shape social and political stability. Social protection programs, such as targeted subsidies, are critical to mitigating discontent and ensuring equitable access to necessities.

Long-Term Outlook

Sustained inflation over the next three to five years could dampen economic growth by reducing purchasing power and creating investment uncertainty. The effectiveness of monetary and fiscal policies will determine Indonesia’s ability to attract foreign direct investment and maintain its appeal as an investment destination. A focus on structural reforms, including digitalization and infrastructure development, will be key to sustaining growth.

Alternative Scenarios

Several scenarios could alter the inflation trajectory. A spike in oil prices beyond $80 per barrel would push inflation toward 4 percent, straining household budgets and industrial costs. Aggressive global monetary tightening, particularly by the Federal Reserve, could trigger capital outflows, weakening the rupiah and amplifying import-driven inflation. A significant rupiah devaluation would exacerbate these pressures, necessitating swift policy responses to stabilize markets.

Sentiment and Behavioral Shifts

Public and business sentiment, as reflected in surveys and market indicators, remains cautiously optimistic. Stable inflation expectations, supported by Bank Indonesia’s credibility, bolster consumer and investor confidence. However, rising food prices could shift consumer behavior toward more affordable goods, while businesses may adopt cost-cutting measures or adjust pricing strategies to maintain profitability. Digitalization is enabling SMEs to adapt, but broader adoption is needed to fully mitigate inflationary impacts.

Conclusion: Charting a Stable Path Forward

Indonesia’s economy is poised for continued growth in 2025, underpinned by robust domestic demand and effective policy frameworks. However, inflationary pressures from global commodity prices, domestic demand, and potential currency depreciation require vigilant management. Bank Indonesia’s monetary tools, combined with the government’s fiscal strategies, provide a solid foundation for maintaining inflation within the target range of 2.5 percent plus or minus 1 percent. By strengthening domestic production, enhancing digitalization, and sustaining social protection, Indonesia can navigate these challenges while preserving economic stability and growth.

This newsletter highlights the interconnected nature of inflation’s drivers and impacts, offering a roadmap for stakeholders to anticipate and address emerging risks. As Indonesia charts its economic course, coordinated policies and strategic foresight will be essential to ensuring a prosperous and stable future.