Indonesia’s economy grew more than expected in 2Q-2026, but investor confidence remains the key challenge

Indonesia's economy expanded by 5.29% YoY in 2Q-2026, exceeding market expectations of around 5.1%, although moderating from 5.61% in the first quarter. This reflects that the country's economic fundamentals remain resilient and capable of withstanding global economic uncertainty to some extent. However, the stronger-than-expected GDP figure has not been sufficient to restore investor confidence, as markets are placing greater weight on the credibility of economic policy than on growth alone.

• Investment and government spending supported the economy, while consumption momentum began to weaken

Although household consumption remained the main driver of the economy, accounting for 53.3% of GDP and expanding by 5.06% YoY in the second quarter, it slowed from 5.52% growth in the previous quarter. This suggests that household purchasing power is beginning to be affected by higher living costs and rising interest rates. At the same time, imports accelerated due to higher energy prices stemming from the Middle East conflict, causing imports to grow faster than exports and resulting in net exports weighing on economic growth during the quarter.

However, investment and government spending accelerated and compensated for this weakness. Private investment expanded by 6.87%, particularly in downstream industries, while government spending surged by 15.97% due to accelerated budget disbursement, public projects, and support measures for households. As a result, domestic demand remained the primary engine of economic growth during the quarter.

In terms of production, nearly all major sectors continued to expand, led by manufacturing at 4.52%, construction at 6.68%, wholesale and retail trade at 6.39%, and services. Mining was the only sector to contract, declining by 1.64% due to production quota restrictions and slower output in certain mineral categories.

• The economy is expected to slow in the second half of the year, while policy space is becoming more limited.

Although the 2Q-2026 economic growth exceeded expectations, several indicators suggest that economic momentum may weaken during the second half of 2026. Consumer confidence has declined continuously since the beginning of the year, reaching its lowest level in June, while retail sales contracted throughout the second quarter. In addition, the cumulative 100-basis-point policy rate hike during May and June will gradually be passed on to financing costs of businesses and households.

To mitigate the impact on purchasing power and support growth in the second half of the year, the government has introduced a stimulus package worth IDR26.34 trillion, equivalent to around 0.1% of GDP. The package focuses on targeted measures such as transportation discounts, rice handouts, and workforce skill development programs to support short-term purchasing power, with impacts expected to become visible in the third quarter. At the same time, the government must continue financing flagship projects and address risks associated with energy subsidies if global oil prices remain high, limiting fiscal space for further stimulus measures.

Meanwhile, Bank Indonesia (BI) also faces tighter constraints in conducting monetary policy. After raising interest rates by a cumulative 100 basis points, BI kept its policy rate unchanged at 5.75% in July and shifted toward alternative measures, such as reducing foreign exchange hedging costs and promoting local currency transactions (LCT), to support the currency without further rate hikes. This reflects the fact that both fiscal and monetary policies are operating under increasing constraints in supporting the economy during the second half of the year.

• Investors continue to monitor three key issues that could shape the economic outlook. 

Although the real economy continues to perform relatively well, financial markets have not responded positively. Investors are assessing the credibility of the economic policy framework rather than focusing solely on GDP figures. Three major issues are attracting market attention:

1. Central bank independence following the resignation of BI Governor Perry Warjiyo, markets are closely watching the appointment of a new governor and whether monetary policy independence can be maintained. This concern arises amid the government's growing role in promoting initiatives through state-owned banks, which may raise questions about the consistency between fiscal and monetary policies.
2. State-owned enterprise reforms under Danantara's management, particularly the recent takeover of Pos Indonesia, the state-owned postal company that has suffered significant losses. This is seen as a crucial first test of whether the fund can truly improve the governance of problematic state-owned enterprises, as previous reforms have focused primarily on mergers and acquisitions and efficiency improvements.
3. MSCI's review of Indonesia's equity market status in November. Investors are awaiting further progress on governance reforms and capital market structural improvements before any decision is reached.

These concerns are clearly reflected in financial markets. Indonesia's stock market index has fallen 26.6% since the beginning of the year, while foreign investors have recorded net equity sales of more than IDR 73 trillion. The 10-year government bond yield has risen to 7.3%, and the rupiah has depreciated by 6.96% since the start of the year to IDR18,037/USD (as of August 5). This suggests that investors are assigning greater importance to the credibility of economic policy than to economic growth alone.

• Indonesia's economy is expected to grow by 5.1% in 2026. Economic fundamentals remain solid, but confidence will determine the direction going forward. 

KResearch expects Indonesia's economy to expand by around 5.1% in 2026, supported by consumption, investment, and government spending, despite an anticipated moderation in momentum during the second half of the year. However, Indonesia's key challenge going forward will be restoring confidence in government economic policies amid the constraints facing both fiscal and monetary policy. If the government can rebuild confidence, financial market volatility should gradually ease. If confidence fails to recover, the risks currently evident in financial markets could eventually spill over into real economic activity.​

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