Rising geopolitical risks may push oil prices higher. The involvement of the US in the Israel-Iran war marks a further escalation in tensions and could drive oil prices even higher, especially if followed by Iranian retaliation. Oil prices have risen by 9.1% since Israel s initial strike on Iran on 13 June, bringing the year-to-date average to USD72/bbl still below the 2025 budget assumption of USD82/bbl. Given Indonesia is a net oil importer, the Rupiah exchange rate is also a critical factor. While the budget assumes an exchange rate of 16,000 per USD, the ytd average has already reached 16,500. This implies a crude oil price assumption of IDR8,252/liter versus an ytd average of IDR7,472/liter.

Limited fiscal room amid oil price surges. In 2025, the government allocated IDR26.7tn for fuel subsidies and IDR191tn for energy subsidy compensation. Our estimate suggests that for every 10% increase in oil prices, the fiscal deficit could widen by 0.1% of GDP even after accounting for the positive impact on government revenue (Exhibit 1). This implies that crude oil could rise by up to 50% from the assumed USD82/bbl to around USD120/bbl before the deficit reaches the 3% of GDP threshold, up from the 2.5% target this year (Exhibit 2). However, the fiscal space may not be that ample, given the potential revenue shortfall and further Rupiah depreciation beyond the budget assumption.

Oil at USD100 may force Pertalite hike. As such, we believe the government may be forced to raise the subsidized Pertalite fuel price if the full-year average crude oil price reaches USD100/bbl, which implies an average of USD127/bbl in 2H, compared to USD72/bbl in 1H. In our estimate, for every 10% increase in crude oil prices would raise inflation by only 0.1%. The same increase in subsidized Pertalite fuel would result in a 0.5% rise given fuel’s 5% weight in the CPI. Including second-round effects on transport fares and food prices, the total increase could reach 0.7 1.8 percentage points (Exhibit 3).

Politics may delay fuel price hike. The decision on subsidized fuel prices is not purely economic it is also political. It s hard to imagine President Prabowo sharply raising prices, given his populist stance. We should not rule out the possibility of maintaining current prices despite rising subsidy costs, with the government reallocating budgets from other spending items. Conversely, the government may allow fuel prices to rise to preserve funding for flagship programs. In September 2022, despite the room to keep prices stable, the government raised them by 33%, arguing that subsidies were not benefiting the poor.

Oil spike risks wider CAD. Higher oil prices will worsen trade balance. Our analysis indicates that a 10% rise in crude oil prices would reduce the current account balance by 0.1% of GDP (Exhibit 4). The continued surge in oil prices poses a risk to our CAD forecast of 1.5% of GDP, widening from 0.6% last year. This forecast also reflects the potential impact of the US reciprocal tariffs, possibly taking effect in July. Additionally, if the war disrupts cargo shipping routes, it will not only push oil prices higher but also increase freight costs (Exhibit 5). Indonesia s annual freight bill is approximately 0.5% of GDP.

War-driven inflation may limit BI Rate cuts. We still expect BI to cut its policy rate by another 50bp to 5.00% in 2H25, reflecting a more pro-growth stance. However, the escalating war could not only push oil prices higher and increase inflation but also trigger flight-to-safety flows, weakening the Rupiah. If the government raises the subsidized Pertalite fuel price by 33% like the move in Sep-22 after oil prices hit USD120-130/bbl (Exhibit 6) we expect inflation to rise to 8.4%, implying a full-year average of 4.4%, breaching BI s 1.5 3.5% target range. As such, we now see the risk of BI turning more cautious, potentially cutting the policy rate by less than 50bp this year.