BI Aggressively Raises Rate: Rupiah Rescued, Economy Sacrificed?

Bank Indonesia (BI) has further tightened its monetary policy by raising its benchmark interest rate. This move responds to significant pressure on the rupiah exchange rate amid global volatility. During a Weekly Board of Governors Meeting on Tuesday, BI decided to raise the BI-Rate by 25 basis points to 5.50%. The Deposit Facility rate also rose by 25 bps to 4.50%, whilst the Lending Facility rate increased by 25 bps to 6.25%. BI Governor Perry Warjiyo stated that this hike is a follow-up measure to strengthen rupiah stabilisation from the impact of high global turmoil caused by the war in the Middle East. Furthermore, the policy serves as a pre-emptive step to keep inflation within the 2.5%±1% target range for 2026 and 2027. This hike continues BI’s tightening after the central bank previously raised the BI-Rate by 50 bps at the Monthly Board of Governors Meeting on 19-20 May 2026. Consequently, the benchmark rate has risen by 75 bps in under a month. BI’s aggressive tightening has indeed revived the previously lethargic rupiah. The rupiah exchange rate strengthened by 0.66% on Tuesday to Rp 18,050 per US dollar.

Looking at historical data, when Bank Indonesia tightens or raises its benchmark rate, several economic indicators are affected. However, the impact is not always immediately visible in the same year due to a lagging effect. Generally, a rate hike makes the cost of funds in the financial system more expensive. This condition can then be transmitted to bank lending rates for consumer credit, working capital, and investment. When lending rates become more expensive, loan demand from businesses and the public tends to slow. Companies may postpone expansion, whilst households may hold back on purchasing high-value goods requiring financing. Therefore, the clearest impact of a rate hike is usually seen in bank credit growth and its effect on economic expansion and inflation. In the context of inflation, raising interest rates serves as a monetary tool to help suppress price pressures.

This condition was clearly evident in 2005. At that time, BI aggressively raised the benchmark rate by 425 bps. The large increase occurred when Indonesia faced very high inflationary pressure, partly triggered by a fuel price hike at the time. The impact was strongly felt in bank credit growth the following year. Credit growth, which still reached 28.44% in 2005, dropped sharply to just 12.70% in 2006. The rate of credit growth was thus more than halved within a year of the massive rate hike. Regarding its effect on inflation, the high interest rate policy successfully suppressed price pressures. Inflation, which soared to 17.10% in 2005, fell significantly to 6.60% in 2006. This indicates that monetary tightening was quite effective in curbing inflation. However, the consequence was still felt in the real economy. Indonesia’s economic growth also decelerated from 5.69% in 2005 to 5.49% in 2006. The decline was not as deep as that of credit, but it still showed that the rate hike restrained economic activity.

A similar condition was seen in 2013. Back then, BI raised the benchmark rate by 175 bps. That tightening occurred amid more complex pressures: rising inflation, a weakening rupiah, and a sizable current account deficit. Inflationary pressure in 2013 was also influenced by a subsidised fuel price hike. Simultaneously, the rupiah was under pressure as capital outflows from developing countries increased, following changes in market expectations regarding US monetary policy. In that year, bank credit growth was still fairly high at 21.39%. However, in the following year, credit growth fell sharply to 11.56% in 2014, then slowed further to 10.12% in 2015. This means that within two years of the 2013 rate hikes, the pace of bank credit nearly halved. The impact on economic growth was also visible. Indonesia’s economy, which grew 5.56% in 2013, slowed to 5.01% in 2014 and fell again to 4.88% in 2015. Meanwhile, inflation remained high in 2014 at 8.36%, almost the same as the 8.38% recorded in 2013. However, inflation then dropped significantly to 3.35% in 2015. This demonstrates that the effect of rate hikes in curbing inflation also takes time.

Subsequently, in 2018, BI again raised the benchmark rate by 175 bps. Unlike 2005, which was predominantly triggered by inflation, the 2018 rate hikes were directed more at maintaining rupiah stability amid external pressures. At the time, global financial markets were overshadowed by the US Federal Reserve’s rate hikes. This condition drove a strengthening US dollar and made dollar-based assets more attractive. Pressure was also exacerbated by rising trade war tensions between the United States and China. The situation triggered a risk-off sentiment in global markets, leading investors to exit emerging market assets and seek those considered safer. Under these conditions, the rupiah came under pressure along with other emerging market currencies. BI then raised rates to maintain the attractiveness of domestic financial assets, curb pressure on the rupiah, and strengthen Indonesia’s external resilience. At that time, bank credit growth was still at 11.72%. A year later, in 2019, credit growth slowed to 6.08%.