Macro Strategy

The Resilience Test

 

  • Our historical analysis suggests that Indonesian markets may be more resilient to foreign outflows than commonly perceived.
  • Improving sentiment and clearer domestic policies are supporting market recovery, though sustainability remains the key challenge.
  • Restrictive monetary policies are becoming the main market risk, potentially slowing growth and weakening capital flows.

 

When Markets Defy Foreign Selling. Despite persistent foreign selling, equity market has seen considerable rebound from recent lows. Our historical analysis suggests that Indonesian financial markets may be more resilient to foreign outflows than commonly perceived. In many cases, improving risk catalysts such as better macroeconomic conditions, policy support, attractive valuations, or easing external uncertainties have played a larger role in driving market performance than a mere foreign flow trends. As domestic participation has grown and policy support has become increasingly effective, market direction has become less dependent on foreign investor behavior than in previous cycles. To assess this resilience, we conducted a historical event study using three observation horizons: 4, 8 and 12-week cumulative flows. For equities, a divergence episode is defined as a period when foreign investors remain net sellers while the JCI delivers a return of more than 3%. For bonds, divergence occurs when foreign investors continue reducing their government bond holdings while the 10-year government bond yield declines, indicating rising bond prices. While the 4-week framework is more influenced by short-term positioning and market noise, the 8-week and 12-week frameworks produce highly consistent results across both asset classes.

 

Across both equities and bonds, divergence episodes are generally temporary and often occur when strong domestic demand, improving sentiment, or credible policy support outweigh foreign selling pressure. In many cases, foreign investors only return after market strength has become well established and the rally has proven sustainable. This pattern is particularly evident in equities, where several of the longest divergence episodes were later followed by prolonged periods of foreign inflows, suggesting that foreign investors often wait for confirmation before rebuilding exposure.

 

Equity: The divergence episodes in equities are relatively common and reflect the growing role of domestic investors in driving market performance. Using the 12-week framework, we identified 33 divergence episodes since 2010, with an average duration of around three weeks and a maximum duration of 19 weeks. While most episodes were short-lived, notable periods including late 2017 to early 2018, 2H23, and May–Sep 25 demonstrated that the equity market can remain resilient despite continued foreign selling. These longer episodes often coincided with improving domestic risk appetite, attractive valuations, or stronger earnings expectations. Importantly, many were later followed by meaningful foreign re-entry. Following major divergence episodes in 2014, 2018, 2023, and 2025, foreign investors eventually returned and accumulated Indonesian equities for extended periods, supporting the view that foreign investors could also tend to follow market.

 

The current environment is therefore not without precedent. Historical evidence shows that the JCI can continue to advance despite persistent foreign selling when supported by strong domestic participation and improving market sentiment. While divergence episodes can last several weeks, or even months in more extreme cases, foreign investors have typically returned within one to three months after market strength became more established, although some episodes took four to six months before meaningful inflows resumed.

Fixed Income: Differ from equity, the bond market tells a different path. At first glance, the lower number of divergence episodes relative to equities may suggest that bonds are more sensitive to foreign selling. However, such a conclusion would overlook the significant structural changes that have taken place in Indonesia's government bond market over the past decade. Foreign ownership has declined from nearly 40% before the pandemic to around 13% currently, reducing the market's direct dependence on foreign participation. At the same time, domestic institutions have become increasingly important. Insurance companies, pension funds, banks, and particularly Bank Indonesia have expanded their role as stabilizing investors. Bank Indonesia's share of government bond ownership has risen from around 10% at the end of 2019 to nearly 28% currently, creating a much larger domestic buffer against foreign outflows. As a result, divergence episodes in bonds are increasingly linked not to foreign demand, but to the ability of domestic institutions and policy support to absorb selling pressure.

 

This structural shift became particularly evident during the September–December 2025 episode, the longest bond divergence period in our sample. Despite persistent foreign selling, 10-year government bond yields continued to decline for 16 consecutive weeks as domestic demand remained strong and policy support helped anchor market confidence. Similar, albeit shorter, episodes were also observed in 2011, 2021, and 2022. These findings suggest that the bond market's resilience today is fundamentally different from previous cycles. Without the rise in domestic institutional ownership and BI's expanded presence, bond yields would likely have been significantly more vulnerable to foreign outflows.

 

The Emerging Positive Factors. Market turning points are often shaped by improving fundamentals rather than investor positioning alone, particularly once worst-case outcomes have been largely discounted. Recent developments on both the global and domestic fronts have helped improve risk sentiment and provide a more constructive backdrop for financial markets. For the rally to become more durable, however, these positive trends will need to be sustained.

 

  1. Externally, Brent crude prices declined to c.USD80/bbl last week although the outlook remains highly dependent on the fragile U.S.-Iran diplomatic process. Following the US-Iran deal agreement, several Saudi-flagged supertankers carrying around 6 million barrels of crude transited the Strait of Hormuz, representing the first major movement of Saudi oil shipments since the onset of the conflict. While shipping activity may take time to fully normalize and geopolitical risks remain, the easing of supply disruption concerns has supported global risk appetite.
  2. Domestically, the policy direction has become increasingly clear. Bank Indonesia has adopted a more cohesive policy stance, with a series of rate hikes underscoring its priority on stability. Unlike previous tightening episodes that relied mainly on short-term rate adjustments, the latest measures have been broader and more comprehensive. The move also suggests a greater degree of policy independence in pursuing its stability mandate. Furthermore, concerns surrounding DSI also moderated following a recent clarification meeting. DSI emphasized that its current role remains focused on facilitation, supervision, and data-based oversight rather than replacing existing commercial relationships. Although the possibility remains that DSI could act as a single trader or intermediary under Phase 2 implementation in 2027, management stressed that any future commercial arrangement would prioritize fairness and value creation rather than rent extraction from miners. This helped alleviate some of the uncertainty that had weighed on market sentiment.
  3. Concerns surrounding Indonesia's MSCI status also partially eased following the release of the latest Market Accessibility Review. Indonesia still recorded positive remarks across the assessed categories, comparing favourably with many emerging market peers. While MSCI continued to highlight issues such as FX volatility, these concerns remain broadly comparable with other emerging markets. The most notable negative development was the downgrade of the Information Flow category from "+" to "-", reflecting concerns over limited transparency in shareholding structures and coordinated trading activity. Nevertheless, the overall outcome was broadly in line with market expectations, reinforcing the view that Indonesia is likely to retain its Emerging Market classification. The next key factor to watch would be the release of MSCI Annual Classification Review (23rd June), with base case of Indonesia’s to retain EM status.

 

What’s The Key Risks Ahead. As geopolitical risks gradually recede, monetary policy is emerging as the dominant risk for financial markets. Recent policy signals suggest that central banks are becoming increasingly willing to tolerate slower growth in order to safeguard inflation and currency stability. This shift toward a more restrictive policy environment has raised concerns over tighter financial conditions, weaker capital flows, and slower economic momentum. Against this backdrop, this week's FOMC meeting marked a notable shift in policy expectations:

  • The Fed continues to view the economy as resilient, supported by solid growth, strong productivity and business investment, a stable labor market, and inflation that remains above the 2% target. Reflecting this assessment, the median 2026 policy rate projection was raised to 3.8% from 3.4%, while GDP growth was revised lower to 2.2% from 2.4%.
  • Chair Warsh emphasized that "The Committee will deliver price stability." For a chairman previously viewed as supportive of lower rates, the message was notably hawkish and underscored the Committee's "unambiguous and unanimous" commitment to controlling inflation.
  • The Fed also reaffirmed its "ample reserves" framework, signaling no immediate plans to reduce its USD6.7tn balance sheet despite Warsh's earlier support for balance sheet normalization.
  • Despite holding rates, policymakers are now evenly split (9-9) between those expecting rates to remain unchanged or decline modestly and those anticipating at least one rate hike. As a result, the median 2026 Fed Funds Rate projection rose to 3.8% from 3.4%, implying a shift from one 25bps cut to one 25bps hike relative to the current policy rate. As expected, Warsh did not submit an individual rate projection and instead announced task forces to review the Fed's communication framework and broader operations.

 

Following the meeting, markets increasingly priced in a downside scenario of up to two rate hikes by year-end. This pushed short-end U.S. Treasury yields higher and lifted the Dollar Index above 100, surpassing levels seen during the peak of Middle East tensions earlier this year. The stronger dollar and higher yields create additional headwinds for capital flows into emerging markets and add pressure on Rupiah stability despite improving geopolitical conditions.

 

Against this backdrop, Bank Indonesia (BI) continued to move proactively by raising the BI Rate another 25bps to 5.75%, following the cumulative 75bps tightening delivered over the previous month. BI also strengthened several measures aimed at supporting the Rupiah and attracting capital inflows:

  • BI lowered the threshold for cash FX purchases without underlying transactions to USD10,000 from USD25,000 previously. Transactions supported by underlying documents remain unrestricted, including current account, capital account, financial account, trade financing, investment financing, and other approved transactions.
  • BI continued to intensify FX and monetary operations through SRBI auctions while reducing FX hedging swap costs by 10%. In two auctions last week, SRBI absorbed IDR48tn of liquidity at average awarded yields of 7.5%-7.6%, above the 1-year SBN yield of 7.16%. This continues to reinforce the crowding-out effect observed during the 2023-24 SRBI cycle, with corporate bond issuance reaching only around IDR6tn in June 2026 compared with IDR20tn in the same period last year.
  • BI maintained an accommodative macroprudential stance by increasing the maximum Foreign Funding Ratio (RPLN) from 35% to 40% of bank capital, effective 1 July 2026, to broaden banks' funding sources and support credit growth.

 

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