Indonesia's Yield Curve Steepening: A Double-Edged Opportunity Amid Policy Unwinding

The Indonesian yield curve faces a critical inflection point as Bank Indonesia (BI) contemplates unwinding its aggressive bond market interventions. After years of buying government securities to stabilize the rupiah and support liquidity, BI's gradual retreat from this strategy could create a steepening yield curve—short-term rates rising faster than long-term yields—as fiscal and external risks loom. For investors, this presents a tactical opportunity to position in long-dated bonds while hedging against contingent risks stemming from corporate debt overhang and the fragile sovereign-bank nexus.

The Case for Yield Curve Steepening

BI's Q2 2025 interventions—aggressive purchases of government bonds (SBNs) and targeted liquidity injections—have artificially suppressed short-term rates. The central bank's SBN buying spree, akin to quantitative easing in developed markets, has kept yields anchored at the short end of the curve. However, as global pressures ease and the rupiah stabilizes near Rp16,500/USD, BI may scale back these purchases to avoid perceptions of debt monetization. This unwinding would likely push short-term rates upward, as market-driven demand replaces central bank support.

Meanwhile, long-term yields could remain subdued despite fiscal pressures. Growth forecasts of 4.7–5.5% in 2025, underpinned by infrastructure spending and reforms like Danantara's public-private partnerships, are likely to attract sovereign bond demand. Foreign investors, lured by Indonesia's current account surplus and inflation under control (projected at 3.5% in 2025), may continue buying long-dated SBNs, anchoring yields.

Risks: Corporate Debt and the Sovereign-Bank Nexus

The steepening scenario hinges on two critical risks. First, Indonesia's corporate debt-to-GDP ratio, now at 55%, remains vulnerable to rising funding costs. Banks like Bank Central Asia (BBCA.JK) and Bank Mandiri (BMRI.JK) face margin pressures as funding costs have risen 100 basis points since 2022, complicating their ability to pass through higher rates to borrowers. A sharp spike in short-term rates could strain companies with dollar-denominated debt, particularly in the property sector, which already faces a 87.5% loan-to-deposit ratio in banks.

Second, the sovereign-bank nexus poses systemic risks. Indonesian banks hold 25% of government bonds, creating a feedback loop: if sovereign yields rise due to fiscal slippage (the deficit is projected at 2.9% of GDP), banks' bond portfolios could suffer mark-to-market losses, squeezing capital buffers. Conversely, if BI delays policy normalization to protect banks, it risks missing the window to steepen the curve.

Investment Strategy: Steepening Play with Hedging

Investors should exploit the steepening potential by overweighting long-dated SBNs (e.g., the 10-year IDR bond at 7.25%) while hedging short-term rate volatility. A tactical allocation to instruments like the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) or direct purchases of SBNs via local brokers can capture the long-end gain.

To hedge, consider short positions in short-term SBNs or inverse ETFs tracking Indonesian rates. Additionally, monitor the rupiah's stability; a sustained dip below Rp16,000/USD could force BI to delay policy unwinding, flattening the curve.

Final Word

Indonesia's yield curve is poised to steepen as BI recalibrates its interventions, but investors must navigate corporate debt risks and the fragile sovereign-bank link. The reward is significant—long-dated bonds could yield 100+ basis points in spread gains—but the path requires vigilance. Position defensively, and let the curve work for you.

This analysis is based on current macroeconomic conditions and may not account for unforeseen policy shifts or external shocks.