Bank Indonesia cut the benchmark rate by 25bp to 5% on Wednesday, in line with our off-consensus call. With high frequency activity indicators pointing to a softer growth momentum in second half of the year, and a difficult global trade environment, the BI demonstrated a growth supportive stance by a back-to-back rate cut. Credit growth slowed further to 7.6% yoy in Jun25, compared to average 11% growth in 2024. The decision also came against the backdrop of manageable inflation and rangebound USDIDR, as authorities pushed for faster transmission of the 100bp rate reduction undertaken to date. With the US Fed also expected to resume policy easing next month, we expect the BI to retain a dovish hue in 4Q25. With our forecast of the 5% terminal rate now met, we build in the likelihood of another 25bp cut in 4Q25. The central bank will continue to be opportunistic in lowering rates, tapping periods of relative market stability.
Concurrent to a dovish policy outlook, the government sought to balance welfare spending plans with the need to consolidate finances in 2026. Indonesia President Prabowo tabled key targets for Budget 2026, with a focus on fulfilling people’s basic needs (food, health, education etc.), improving human capital, modernising military, and expanding state investment agency, Danantara’s capabilities. The breakdown pointed to a 7% yoy increase in spending in 2026, coupled with 10% yoy rise in state revenues. The math to narrow 2026 fiscal deficit to -2.5% of GDP from this year’s projected 2.8%, rests on a strong revenue assumption (+13% yoy in tax revenues) and firm growth target for 2026 (at 5.4%). Prima facie, the decision to keep the deficit target below the mandated -3% of GDP threshold is positive for the markets. Nonetheless, optimistic growth and revenue assumptions keep the door open for a miss, in the absence of fresh tax generating measures, and moderate commodity prices The government plans to tap internal reforms to improve collection, likely banking on a wider tax base, better due diligence and crackdown on illegal resource industries/ activity. Social welfare priorities will continue, with the flagship free nutritious meals program allocated IDR 335trn vs IDR 121trn in 2025. However, given the weak year-to-date run rate (at less than 10% by mid-year), actual spending will be undershot. Infrastructure focus remained with the public works ministry also allocated a bigger budget. On the financing end, bond issuance next year is targeted to rise to a record high of IDR 749.2trn, which will require borrowing costs to stay contained and the rate easing cycle to continue. Indications are that pre-funding exercise in 4Q25 coupled with cash reserves might help to manage supply concerns. Our forecast for this year and 2026 is for the fiscal deficit to stay closer to 2.9% of GDP, baking in revenue slippage risks. Any deterioration in the fiscal run-rate is likely to adjusted by scaling back expenditure during the year. 
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