Indonesia’s central bank is finding itself under sharper investor scrutiny after Governor Perry Warjiyo confirmed a new “burden-sharing” arrangement with the government.

In a piece by Capital Economics, it’s detailed that the deal, which includes splitting costs on social programmes and raising interest paid on state deposits, came just days before the sudden ousting of finance minister Sri Mulyani. For markets, the sequence has raised a familiar question: how independent is Bank Indonesia, and how long can it stay that way?

Capital Economics cautions that, in emerging markets, perceived erosion of central bank autonomy usually triggers a rise in inflation expectations and forces policy rates higher in the long run. Investors in Indonesian bonds and the rupiah are watching closely for early signs of that playbook unfolding.

From pandemic support to fiscal integration

Bank Indonesia’s reputation was built on the independence granted in 1999 after the Asian crisis. That autonomy underpinned two decades of credibility, helping anchor inflation expectations and stabilise the rupiah. But the central bank’s pandemic-era interventions blurred the line between monetary and fiscal policy. Its purchase of large volumes of government debt was unusual, given that policy rates never fell below 3.5%.

The 2023 mandate revision, adding “sustainable growth” alongside price stability, sharpened investor concerns. While not unusual in theory, the expanded remit left the impression that BI may tilt toward political priorities over inflation discipline, especially under a government intent on pushing ambitious spending programmes.

Markets lose a trusted anchor

The sudden exit of Sri Mulyani has been a shock to investors. She was regarded as a credible counterweight to political pressure and a defender of institutional integrity. Her removal now leaves markets questioning whether fiscal expansion and political influence will weigh more heavily on BI’s decisions.

Capital Economics notes that this is not just about personalities. Investors tend to reprice risk quickly when they suspect monetary authorities are being leaned on. Any signal that BI is cutting rates faster than justified by inflation data, or stepping further into fiscal financing, could see the rupiah weaken and bond yields spike.

The Turkey playbook investors fear

The concern is not hypothetical. Turkey’s central bank is the most glaring example of how political interference can derail stability. Years of pressure to hold rates down produced runaway inflation above 80% in 2022, collapsing investor confidence and leaving policymakers scrambling to restore credibility. Even today, inflation remains above 30%.

Capital Economics argues that Indonesia is nowhere near that point, headline inflation is still subdued at 2.3% in August, well within target. But the lesson from Turkey is clear: once expectations unmoor, recovery is slow and costly. Investors therefore tend to move pre-emptively, adjusting exposure before policy credibility is visibly lost.

What investors should watch

For now, Indonesian markets remain calm. Inflation expectations are contained, and foreign appetite for local bonds has held up. Yet the risks are asymmetrical. Clear signs of political pressure, calls for faster rate cuts, expansion of debt purchases, or changes to BI’s leadership, would likely trigger a sell-off.

The bottom line, as Capital Economics stresses, is that central bank credibility is a fragile asset. For investors in the rupiah and government debt, the stakes are clear. A perception that Bank Indonesia’s independence is slipping could set off a chain reaction across asset classes.

The rupiah would likely come under depreciation pressure, as seen when it dropped more than 1% after Sri Mulyani’s removal, with foreign holders turning risk-averse. Government bond yields could climb, particularly at the long end, as investors demand higher returns even if BI steps in to buy debt. Capital inflows and foreign direct investment may also dry up, echoing recent bond and stock sell-offs, while credit ratings could face renewed pressure if fiscal deficits widen or inflation expectations drift. As Reuters has reported, these risks underscore that policy credibility remains one of Indonesia’s most valuable, and most vulnerable, assets.