Indonesia Faces Economic Shock as Bank of Japan Hikes Interest Rates

The Bank of Japan’s recent decision to raise its benchmark interest rate to 0.75% marks the highest level in 30 years, significantly impacting Indonesia’s economy. This move, led by BOJ Governor Kazuo Ueda, signals the end of an era characterized by cheap yen financing, which has long supported Indonesia’s rapid industrialization and fiscal stability through the so-called “yen carry trade.” As Japan’s liquidity dries up, Indonesia faces a new economic reality that threatens to reshape its financial landscape.

For years, Indonesia benefitted from a steady influx of Japanese capital, which flowed into government bonds and corporate projects. The end of this financial support signals a critical juncture for Jakarta, which must now address the challenges posed by this shift. The ambitious “Golden 2045” vision, aimed at propelling Indonesia into a top-tier global economy by its centennial, is now at risk of becoming significantly more expensive to achieve.

Immediate Financial Impacts

The most pressing concern for Indonesia’s financial system is the potential for a “violent unwinding” of yen-funded investments. The historical disparity between the BOJ’s near-zero rates and Bank Indonesia’s higher yields attracted considerable foreign investment, bolstering the country’s foreign exchange reserves and stabilizing the rupiah during times of global financial stress. However, with the BOJ’s pivot toward higher rates, the yield gap is narrowing, prompting fears of a mass withdrawal of portfolio investments. Such an exodus could place unprecedented selling pressure on the rupiah, reminiscent of the 2013 taper tantrum that shook emerging markets.

This volatility presents not only a challenge for Bank Indonesia but also poses severe risks to Indonesia’s corporate sector. Many major conglomerates, particularly in energy and manufacturing, are heavily reliant on foreign currency debt. A strengthening yen will inflate the costs associated with servicing this debt, leading to tighter profit margins for companies across the archipelago. Industries ranging from mining in Sulawesi to textiles in West Java will feel the direct financial strain of these changes.

As Bank Indonesia grapples with this situation, it may find itself in a “hawkish trap.” To counteract potential depreciation of the rupiah, the central bank may be forced to raise interest rates, despite the domestic economy’s need for stability. Such a move would increase borrowing costs for the burgeoning middle class and small and medium enterprises (SMEs), which are essential for Indonesia’s ongoing recovery from the pandemic.

Geoeconomic Shifts and Future Dependence

Beyond immediate financial implications, the rate hike signals a profound geoeconomic shift. Japan has historically served as a key partner for Indonesia, providing high-quality investment and infrastructure development. Major projects like the MRT Jakarta and Patimban Seaport exemplify this partnership, which has supported Indonesia’s strategic autonomy amid global power dynamics. However, as the cost of yen-denominated credit rises, Japan’s competitive advantage may diminish, forcing Jakarta to reconsider its financial relationships.

One area particularly impacted is Indonesia’s ambitious nickel-to-electric vehicle (EV) battery pipeline. This sector is central to President Prabowo Subianto‘s industrial policy, aiming to elevate Indonesia’s status in the global economy. Japanese automotive giants such as Toyota, Honda, and Mitsubishi have dominated the Indonesian market, but their ability to transition to EVs may be hampered by rising capital costs linked to BOJ rate increases. In contrast, Chinese firms like BYD and CATL could become more competitive, potentially filling the void left by Japan.

As Japan’s investment becomes more selective and costly, Indonesia’s reliance on China for its green transition may deepen significantly. This shift could lead to a pivotal change in Jakarta’s foreign economic policy, moving from a strategy of balance between major powers to one of increased dependence on Chinese capital and support.

Looking ahead to 2026, Indonesia’s financial landscape will likely reflect this forced integration with China. As Japanese foreign direct investment retreats, a corresponding surge in yuan-denominated trade and investment is expected. The new reality for Indonesia will be one where its economic trajectory is increasingly shaped by its financial ties to Beijing rather than Tokyo.

The BOJ’s recent rate hike not only seeks to stabilize the yen but also sets the stage for a transformation in Indonesia’s economic dynamics. The era of inexpensive yen financing is drawing to a close, leading Jakarta into a future characterized by greater financial constraints and a shifting geopolitical landscape. As Indonesia strives to fulfill its “Golden 2045” vision, the challenges ahead will demand careful navigation of both economic volatility and evolving international relationships.