Week 2 – June 2025: Indonesia’s Inflation Edge: Navigating Trade Tensions and Price Pressures in a Shifting Global Economy

Bank Indonesia’s target range of 1.5% to 3.5%, with the annual rate at 1.60% in May 2025, down from 1.95% in April

As we step into Week 2 of June 2025, Indonesia’s economy stands at a critical juncture. The nation is balancing the need to control inflation, which dropped to 1.60% in May 2025, with the imperative to sustain growth, which slowed to 4.87% in the first quarter of 2025. This newsletter explores a singular theme: the intricate interplay between inflation and economic growth, shaped by domestic policies and global pressures. From monetary decisions to commodity price swings, from labor market dynamics to geopolitical risks, Indonesia’s economic path is a tightrope walk that demands precision and foresight. Join us as we unpack the latest developments, project inflation trends for the next 12 months, and analyze their implications for households, businesses, and the nation’s future.

The Economic Landscape: A Snapshot of June 2025

Indonesia’s economy in June 2025 reflects both resilience and vulnerability. The first quarter of 2025 saw economic growth slow to 4.87%, down from 5.03% in the final quarter of 2024, signaling challenges in sustaining momentum. Inflation, however, remains within Bank Indonesia’s target range of 1.5% to 3.5%, with the annual rate at 1.60% in May 2025, down from 1.95% in April. This decline, driven by a stronger rupiah and government price controls, offers temporary relief but masks underlying risks. The central bank’s decision to cut its benchmark interest rate to 5.50% in May 2025 aims to boost growth but could fuel inflationary pressures if demand surges. Meanwhile, the rupiah’s appreciation to around 16,250 against the US dollar as of June 10, 2025, has eased import costs, a critical factor given Indonesia’s reliance on imported food and energy.

The past week, from June 4 to June 10, 2025, saw continued stability in consumer prices, though specific data for early June is still emerging. The broader economic context, however, points to a complex interplay of factors: global commodity price volatility, geopolitical trade tensions, and domestic policy adjustments. These elements converge to shape Indonesia’s inflation trajectory, with implications for everything from household budgets to global investor confidence.

Monetary Policy: Stimulus with Strings Attached

Bank Indonesia’s decision to lower its benchmark interest rate by 25 basis points to 5.50% in May 2025 reflects a proactive stance to counter slowing growth. This move, the lowest rate since 2022, aims to stimulate credit and consumption, with loan growth at 9.16% in March 2025, though down from 10.27% in January. The central bank also raised the foreign funding cap for banks from 30% to 35% starting June 2025, enhancing liquidity to support lending. These measures signal confidence in Indonesia’s economic fundamentals but carry risks. Lower interest rates could spur demand, pushing inflation higher, especially if supply constraints persist. Bank Indonesia projects inflation to remain within its 1.5% to 3.5% target through 2026, bolstered by a stronger rupiah and stable global commodity prices. Yet, the central bank must remain vigilant, ready to intervene in currency markets if the rupiah weakens amid global uncertainties.

Global Commodity Pressures: A Double-Edged Sword

Indonesia’s reliance on imported food and energy makes it vulnerable to global commodity price swings. In January 2025, food inflation reached 3.69%, driven by rising prices for cooking oil, chili peppers, and coffee. Energy prices, particularly oil, remain a wildcard, with global supply chain disruptions and geopolitical tensions threatening spikes. A potential escalation in trade disputes, such as proposed US tariffs, could further elevate import costs, pushing inflation higher. Historically, sharp commodity price increases, like those in 2022, have driven Indonesia’s inflation above 5%, a pattern that could reemerge if oil or food prices surge. Conversely, stable global prices and a strong rupiah could keep inflation below 2.5%, supporting household purchasing power and economic stability.

Fiscal Policy: Balancing Subsidies and Stability

The government’s fiscal strategy has been instrumental in curbing inflation. Subsidies for energy and food, including a 50% electricity tariff discount in early 2025, contributed to a brief period of deflation in February. However, the partial withdrawal of subsidies in March 2025 sparked a temporary inflation spike, highlighting their double-edged nature. The state budget deficit, maintained below 2% of GDP, and public debt under 30% of GDP reflect prudent fiscal management. These policies stabilize prices but limit fiscal space for growth-oriented investments. The challenge lies in phasing out subsidies without triggering sharp price increases, which could erode public trust and fuel social unrest.

Labor Market and Wages: A Fragile Equilibrium

Wage growth in Indonesia remains sluggish, with regional minimum wage increases varying widely but generally trailing inflation. This lag constrains household purchasing power, particularly in the informal sector, which employs a significant portion of the workforce. Digitalization and automation, while boosting efficiency, are reducing demand for low-skill labor in retail and manufacturing. For instance, the rise in cashless transactions, with credit card payment growth at 3.2% in 2025, reflects a shift toward digital platforms but also displaces traditional retail jobs. Programs like the Kredit Usaha Rakyat, which disbursed IDR 67.2 trillion in 2016 and continues to support small businesses, are critical for maintaining employment and mitigating inflationary pressures on wages.

Household Consumption: The Engine Under Strain

Household consumption, accounting for roughly 60% of Indonesia’s GDP, is a cornerstone of economic growth. However, the first quarter of 2025 saw a slowdown in retail sales, particularly for durable goods like cars, reflecting weaker consumer confidence. Inflation, though low, has prompted shifts in consumption patterns, with households opting for cheaper local products over imported goods. Retailers have responded with promotions, such as buy-one-get-one deals, to sustain demand. If inflation rises above 3.5%, these shifts could intensify, further dampening consumption and growth. The interplay between inflation and consumption underscores the need for policies that bolster household incomes without fueling price pressures.

Business and UMKM: Navigating Cost Pressures

Micro, small, and medium enterprises (UMSMs), which account for 60% of employment, face significant challenges from rising input costs. Many are absorbing these costs to maintain market share, squeezing profit margins. Digital platforms have helped UMKM reach broader markets, but access to financing remains a hurdle. Government initiatives, such as tax incentives and digital training, are vital for enhancing UMKM competitiveness. Larger businesses, particularly in manufacturing and construction, are grappling with competition from cheap imports, necessitating targeted policies to protect domestic industries while managing inflation.

Financial Markets: A Barometer of Confidence

Indonesia’s financial markets reflect cautious optimism. The rupiah’s strength has bolstered investor confidence, but capital outflows of IDR 10.33 trillion in February 2025 highlight vulnerability to global shocks, such as potential US Federal Reserve rate hikes. Government bonds and equities remain sensitive to inflation expectations, with investors closely monitoring Bank Indonesia’s policy moves. A stable rupiah and controlled inflation could sustain foreign direct investment, which reached USD 55.33 billion in 2024, up 21% from the previous year. However, a sharp rupiah depreciation could trigger capital flight, exacerbating inflationary pressures.

Geopolitical Risks and Supply Chains

Global trade tensions, including proposed US tariffs, pose risks to Indonesia’s import-dependent economy. Disruptions in global supply chains, whether from conflicts or sanctions, could drive up prices for key commodities like wheat and fuel. Indonesia is countering these risks by diversifying exports and strengthening trade ties with alternative partners, such as purchasing US gas and wheat to mitigate tariff impacts. Reducing import reliance through domestic production, particularly in food, is critical for long-term price stability.

Comparative Insights: Lessons from Emerging Markets

Other emerging markets offer valuable lessons. Brazil reduced inflation from 10% in 2022 to 4% in 2024 through aggressive rate hikes, but at the cost of slower growth. India, with inflation around 5% in 2024, has balanced subsidies and monetary tightening to stabilize prices while supporting consumption. Indonesia can adopt India’s targeted food distribution strategies to control inflation without stifling growth, while avoiding Brazil’s overly restrictive monetary approach, which risks stifling investment.

Stagflation Risks: A Distant but Real Threat

While stagflation, the combination of high inflation and economic stagnation, is not imminent, it remains a concern. If commodity prices surge or the rupiah weakens significantly, inflation could rise while growth stagnates, particularly in import-sensitive sectors. Mitigating this risk requires sustained investment in infrastructure and UMKM, coupled with flexible monetary policies to balance growth and price stability.

Social and Political Implications

Public perception of the government’s inflation management is generally positive, bolstered by low inflation and stable food prices. However, regional disparities, such as high inflation in Papua Pegunungan (5.75% in May 2025), could spark unrest if prices rise sharply. Maintaining public trust through transparent policies and targeted subsidies is essential to avoid social instability.

Inflation Projections: Scenarios for June 2026

Using a simple ARIMA model with inputs like historical inflation, commodity prices, and interest rates, we project inflation for June 2025 to June 2026 to range between 2.5% and 3.0%. In an optimistic scenario, a strong rupiah, stable global prices, and effective subsidies could keep inflation below 2.5%, supporting growth near 5%. In a pessimistic scenario, a commodity price spike or rupiah depreciation could push inflation above 3.5%, slowing consumption and investment. A third scenario, driven by aggressive US Federal Reserve rate hikes, could see inflation reach 4.0%, with increased market volatility and capital outflows.

Consumer and Business Behavior: Adapting to Pressure

Consumers are adapting to inflation by prioritizing essential goods and local products, while businesses are leveraging digital tools to cut costs. UMKM, in particular, are turning to e-commerce to expand reach, though financing constraints limit their scalability. Large firms are cautiously adjusting prices to maintain competitiveness, with some investing in automation to offset rising labor costs. These adaptations highlight the resilience of Indonesia’s economy but also its vulnerability to sustained inflationary pressures.

Regional Disparities: A Fragmented Picture

Inflation varies across Indonesia’s regions, with Java experiencing lower rates due to better infrastructure and market access, while areas like Papua face higher prices due to logistical challenges. Addressing these disparities requires targeted investments in regional supply chains and infrastructure to ensure equitable economic stability.

Long-Term Outlook: 2028 and Beyond

If inflation exceeds 3.5% annually, economic growth could stall, eroding purchasing power and deterring investment. However, with prudent monetary and fiscal policies, Indonesia can sustain 5% growth through 2028, driven by FDI and export diversification. Reducing reliance on imported food and energy is critical to long-term stability, as is supporting UMKM through digitalization and financing.

Conclusion: A Call for Balanced Action

Indonesia’s economic tightrope requires careful navigation. The interplay of monetary stimulus, fiscal discipline, and global pressures will determine whether the nation can maintain low inflation while fostering growth. By learning from global peers, investing in domestic resilience, and supporting vulnerable sectors like UMKM, Indonesia can strengthen its economic foundation. This newsletter is a call to action for policymakers, businesses, and citizens to work together to ensure a prosperous and stable future.

Thank you for joining us this week. Stay tuned for next month’s deep dive into Indonesia’s economic journey.