Macro Strategy: The Rating Conundrum

Stock Code	Last Price	Change	Change %
DCII	180,200	6,700	3.86%
MLPT	18,000	3,000	20.00%
PGUN	7,925	1,075	15.69%
POLU	9,800	1,050	12.00%
INKP	8,050	725	9.90%
SINI	10,000	700	7.53%
FORU	3,070	610	24.80%
BBCA	5,625	475	9.22%

Macro Strategy

The Rating Conundrum

Concern is moving from outlook risk toward rating downgrade risk as fiscal and external buffers continue to narrow.
Record-low foreign SBN ownership reflects structural domestic absorption, not full exit, with holdings still above past stress floors.
The earnings yield vs bond yield gap is no longer a reliable market floor, reinforcing our last year “Decoding the Divergence” finding.

Rating on Spotlight. Lingering negative sentiment continues to pressure Indonesian markets, particularly equities, as the “Sell Indonesia” trade appears to be gaining momentum. The JCI is down 35% YTD, the weakest performance in the region, accompanied by IDR65tn of foreign outflows. In the bond market, foreigners have also recorded net outflows, albeit smaller at IDR7tn YTD. Last week’s market derating was partly driven by concerns over a potential downgrade in the upcoming S&P review. As downgrade concerns from BBB to BBB- gain traction, we assess three downside scenarios that could pressure Indonesia’s sovereign rating: deteriorating fiscal affordability, weakening external resilience, and rising government debt metrics. While an outlook revision to Negative remains the market’s base expectation, the risk of an actual rating downgrade is increasing.

The most immediate vulnerability is fiscal affordability. S&P identifies interest payments above 15% of government revenue on a sustained basis as a key downside trigger. Based on our estimates using S&P’s methodology, Indonesia’s interest payment to revenue ratio may have already moved beyond this threshold. The risk is not only driven by higher borrowing costs, but also by a weakening revenue base. Slower commodity exports and softer domestic activity could weigh on royalties, export levies, corporate income tax, and SOE dividend income. As a result, fiscal affordability could deteriorate further even if interest expenses remain broadly stable.

The second, and increasingly important, risk is external resilience. S&P has warned that plans to centralize exports of key commodities, including coal, palm oil, and mineral products, could create execution risks and weaken the balance of payments if implementation disrupts existing trade flows. This concern has become more material as Indonesia’s external position has already started to soften. The trade surplus narrowed sharply to only USD0.09bn in April 2026, the smallest surplus since 2020, while the CAD widened to 1.1% of GDP in 1Q26, the largest deficit since 2019. Commodity exports have also begun to moderate as global demand softens. Against this backdrop, even temporary disruption to export flows could have a disproportionate impact on FX earnings, investor confidence, and government revenues. While Indonesia may still be some distance from breaching S&P’s external financing threshold, the direction of travel is increasingly unfavorable, leaving the sovereign rating more exposed to further deterioration in the external balance.

The third risk relates to government debt metrics, although we view this as the least immediate source of rating pressure. Recent fiscal developments have shown some improvement, with the budget deficit narrowing from 0.93% of GDP in March to 0.70% in May. The government has also introduced spending adjustments, including scaling back the Free Nutritious Meal Program budget from the initial IDR335tn allocation to IDR268tn and potentially lower. These measures should help contain near-term debt pressure, but the broader concern remains that weaker revenue performance and elevated financing needs could gradually erode fiscal space if the growth outlook softens further.

Having said that, the risk balance around Indonesia’s sovereign rating has clearly deteriorated. While Indonesia may not yet have fully breached S&P’s formal downgrade thresholds, the margin of safety has narrowed, particularly on fiscal affordability and external sector resilience. The recent weakening in export performance, rising concern over centralized-export related risks, and heavier fiscal burden suggest that rating pressure is no longer limited to an outlook risk but is increasingly moving closer to rating risk.

A Stable Outlook would require S&P to take a relatively benign view that recent external weakness is temporary and that fiscal risks remain contained. However, this assumption is becoming harder to defend as external buffers weaken and fiscal affordability metrics remain under pressure. A downgrade to BBB-, would become increasingly plausible if export sector disruptions prove more structural, fiscal deficit risks widen further, or interest to revenue metrics deteriorate beyond levels consistent with Indonesia’s current rating category.

Ratings Impact to Foreign Ownership in SBN, our view. Foreign ownership in Indonesia’s SBN market has fallen to a record low of 12.6% as of May 2026, below the previous trough of 13.9% in 2022. However, in nominal terms, foreign holdings remain above IDR800tn, a level that seen as floor during past stress episodes. Since 2014, the SBN market has expanded nearly 7x, while foreign holdings have risen by only 2.6x, with domestic institutions and Bank Indonesia absorbing most new issuance. This suggests the decline in foreign ownership share reflects a structural shift in the investor base, rather than a complete withdrawal of foreign capital. Our key findings are as follows:

The investment grade premium was clearly visible. Foreign holdings rose from around IDR300tn in 2014 to c.IDR750tn by mid-2017, while the ownership share approached 40%, supported by yield seeking flows into a high carry emerging market. After S&P upgraded Indonesia to BBB-, in May-17, and then to BBB in May-19, foreign holdings reached a record high of IDR1,077tn in Jan-20, with the ownership share peaking at 39%.
COVID and the post pandemic period reshaped the ownership structure. In March 2020, S&P assigned a Negative Outlook while maintaining Indonesia’s BBB rating. Foreign holdings fell by around IDR140tn within six months, while the ownership share dropped below 25% as Bank Indonesia stepped in aggressively as a buyer. The adjustment continued through 2021 to 2022, as fiscal deficits stayed above 4% of GDP and the Fed delivered an aggressive tightening cycle. Foreign holdings eventually bottomed at IDR710tn in Oct-22, while the ownership share reached a low of 13.9%.
Most active foreign selling appears to have already occurred. Since Aug-25, c.IDR90tn of outflows appear to have come mainly from active investors. By contrast, foreign governments and central banks, which can be used as a proxy for more passive and long-term holders, have remained broadly stable at around IDR260tn. A similar pattern was seen during the 2022 Fed tightening cycle, when official sector holdings stayed relatively flat at around IDR200 to 210tn despite sizeable active investor outflows.
Downgrade in outlook appears to be priced in, but a Rating downgrade is the real risk. We believe the risk of S&P outlook revision is already largely reflected in the market, given that Fitch and Moody’s have already assigned Negative Outlooks. As such, an outlook revision would likely carry more signal value than shock value as the bigger risk is a one notch downgrade to BBB-. Under this scenario, foreign holdings could potentially fall to test the 2022 trough range of IDR700 to 750tn, implying additional outflows of around IDR100 to 150tn. Our sensitivity analysis suggests this could weaken USDIDR by a further 800 to 1,200 points and lift 10Y INDOGB yields by 40 to 60 bps, potentially surpassing our pessimistic yield scenario of 7.3%. Indeed, government and BI intervention would play major role in reducing volatility. In our view, as one notch downgrade will still land Indonesia at investment grade territory, selling activity from index linked passive funds would appears to remain contain. On the demand side, larger domestic absorption from banks, insurers, pension funds, and retail to seek higher yield could help cushion part of the pressure.

Revisiting our Decoding the Divergence thesis. Foreign investor positioning continues to show a clear divergence between Indonesia’s bond and equity markets. YTD, the JCI has recorded nearly IDR65tn of net foreign outflows, while the SBN market has seen a more modest outflow of around IDR15tn. The performance gap is even more striking. The JCI has fallen below 5,600, down 34.5% YTD, while government bonds have remained relatively resilient, with the 10Y INDOGB yield still stabilizing below 7.0% level.

This reinforces the conclusion from our last year report “Decoding the Divergence” (published 3^rd Mar 2025), that the traditional link between bond yields and equity performance has weakened. In the past, stronger earnings growth could still support equity returns even when the yield curve was flattening, something that is not happening in current juncture. In our view, the equity market is being weighed down by a deeper and more structural higher risk premium. In this context, the equity sell off YTD reflects not only weaker sentiment, but also a broader repricing of Indonesia risk. As such, the earnings yield versus INDOGB bond yield gap appears less reliable as a market floor indicator in the current cycle, reinforcing our earlier findings.

Bond intervention has also created some distortion, as part of the resilience in the SBN market appears to reflect active stabilization measures rather than pure market driven demand. Bank Indonesia has continued its secondary market bond purchases and operation twist strategy, keeping short end yields attractive while helping to limit excessive volatility in longer dated SBN yields. At the same time, the Ministry of Finance has also started to support market stability, with around IDR11tn currently allocated for secondary market bond buybacks.

Domestic demand remains supportive, but investor behavior differs significantly across groups as yields move higher.

Insurance companies and pension funds remain the most consistent buyers across yield levels. Across major tenors and yield regimes, both groups continue to record positive net purchases. At current 10Y yields of around 6.7%, they are buyers on roughly 70% of trading days, with average purchases of around IDR500bn per day. Their demand is mainly driven by liability matching needs rather than short-term yield targets, making them the structural anchor of the SBN market.
Banks remain the most yield sensitive investor group and could become the key source of additional demand if yields rise further. At current 10Y yields within the 6.5 to 7.0% range, banks remain net sellers, averaging around IDR350bn per day. However, buying interest rises meaningfully once yields move above 7%. In the 7.0 to 7.25% range, banks turn into net buyers of around IDR500bn per day, while in the above 7.5% range, purchases rise further to around IDR1.3tn per day. A similar pattern is also visible in the 5Y segment.

Capital Market – Still Not Out of The Woods. Rising yield trend protracted in June as the 10Y UST yield rose by 10 bps w-w to 4.55%, while the 2Y UST yield increased by 19 bps w-w to 4.17%. In the domestic market, the 10Y INDOGB yield also climbed by 15 bps w-w to 6.87%. Indonesia’s sovereign risk indicator, reflected by the 5Y CDS, also widened by 8 bps w-w to 97 bps. Meanwhile, the US Dollar Index strengthened by 0.30% w-w to 99.24, while the rupiah weakened by 0.82% w-w against the US dollar, closing at IDR18,020.

Fixed Income Flows. Despite weaker IDR, foreign investors booked a weekly net inflow of IDR7.71tn into the domestic SBN market (as of 4^th June), bringing total foreign ownership to IDR872tn. On an MTD basis, cumulative foreign inflows reached IDR8.85tn. Among domestic investors, banks recorded a weekly net outflow of IDR1.68tn (MTD net outflow of IDR8.93tn). Bank Indonesia, excluding repo transactions, posted a weekly net inflow of IDR10.22tn (MTD net inflow of IDR15.79tn). Mutual funds also recorded a weekly net inflow of IDR3.81tn, while insurance and pension funds collectively posted a weekly net inflow of IDR10.81tn.
Equity Flows. The JCI fell another 8.7% last week, closing at 5,594, marking its worst weekly decline in 2026 and its lowest level since May 2021. This extended the index’s YTD loss to around 35%. Foreign investors recorded another large outflow of IDR7tn, extending the weekly net outflow streak to 11 consecutive weeks. YTD, the equity market has seen IDR65tn of foreign outflows, with selling pressure concentrated in large cap stocks.

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