Middle East Conflict and the Twin Oil Squeeze on Indonesia's Rupiah

Rupiah Stability Watch · 2026-06-18

The crossing

The rupiah trades at 17,950 per US dollar as of June 10, 2026 — 22% weaker than its January 2025 low and near its worst level in eighteen months. The depreciation reflects portfolio capital outflows and narrowing rate differentials with the Federal Reserve, dynamics this organization has tracked across three publications since early June.

A new pressure has arrived from an unexpected quarter. US military strikes on Iranian radar installations, Israeli offensives into southern Lebanon, and missile attacks reaching Kuwait mark a widening Middle East theater — AGA documented the expansion in signals published June 15. Brent crude oil climbed to $93 per barrel by mid-June 2026, up from a baseline in the low $70s earlier in the year, with market commentary citing supply disruption fears and direct military action around the Strait of Hormuz.

For Indonesia, a net oil importer maintaining subsidies that cover 30–40% of domestic fuel prices, this creates a twin squeeze: higher oil import costs widen the current account deficit (adding pressure on the rupiah), while the fiscal cost of holding subsidies constant balloons (constraining the government's room to intervene in FX markets or deploy counter-cyclical spending). This analysis traces the transmission and quantifies where the new risk lands.

How oil price shocks reach the rupiah

Indonesia imported approximately 430,000 barrels per day of crude oil and refined products in 2025, according to energy ministry data. At $93 per barrel versus a $72 baseline, the additional import cost is roughly $21 per barrel, or $9 million per day — $3.3 billion annualized if the elevated price holds.

That increment flows straight into the current account. Indonesia's current account deficit stood at 0.8% of GDP in Q1 2026. A persistent $3.3 billion oil shock adds roughly 0.25 percentage points to the deficit, bringing it closer to 1% of GDP. Wider deficits require more foreign capital inflows to finance; when global risk appetite is already pulling capital out of emerging markets (the driver behind the rupiah's 22% slide), the additional demand for dollars to pay for oil amplifies depreciation pressure.

The mechanism is direct: oil importers (state-owned Pertamina and private refiners) buy dollars to settle contracts. If Bank Indonesia does not step in to supply those dollars from reserves, the rupiah weakens further. If the central bank does intervene, FX reserves fall — a dynamic already underway, with reserves drawn down by $12 billion between January 2025 and May 2026 to defend the currency.

The subsidy trap

Indonesia's 2026 budget allocated IDR 210 trillion (roughly $12 billion at current exchange rates) for energy subsidies, equivalent to 5% of total state spending. That figure assumed an oil price baseline substantially below $93 per barrel. The Institute for Essential Services Reform estimated in March 2026 that every $10 increase in crude prices above the budget assumption adds approximately IDR 35 trillion to the subsidy bill if retail fuel prices are held constant.

At $93 per barrel, the overshoot is in the range of $20 per barrel, implying an additional IDR 70 trillion burden — a 33% increase over the budgeted subsidy envelope. The government has publicly committed to maintaining subsidized fuel prices unchanged through 2026 despite both the rupiah slide and the oil price surge, as reported by Jakarta Globe on May 20.

This creates a fiscal bind. The subsidy overrun must be funded by either cutting other spending, borrowing more (which raises Indonesia's sovereign risk premium and pressures the rupiah further), or drawing on dwindling reserves. Each option narrows the policy space. A government that spends an additional 0.5% of GDP on energy subsidies has 0.5% less fiscal room to support demand if the economy slows, or to backstop the central bank's FX intervention if capital outflows accelerate.

Where household exposure sits

The twin squeeze matters for Indonesian households in two scenarios, both of which impose costs on the bottom 40% of earners already facing a 3.25% erosion of purchasing power from the 22% rupiah depreciation (quantified in this organization's June 12 publication).

Scenario one: subsidies hold. Retail fuel prices stay constant, insulating households from direct energy cost shocks. The fiscal burden balloons, reducing the government's capacity to defend the rupiah or maintain other safety-net spending. If the rupiah depreciates further — say, another 10% from current levels — the pass-through to imported essentials (cooking oil, wheat, pharmaceuticals) compounds. A household in the bottom 40% currently spending 3.25% more of income on the same basket would face an additional 1.5 percentage point hit, bringing total erosion to nearly 5%.

Scenario two: subsidies adjust. The government lifts retail fuel prices to reduce the subsidy burden, as it did in 2022 when energy costs spiked. A 20% increase in subsidized fuel (Pertalite, diesel) directly raises transport costs, which cascade into food prices (distribution) and services (motorcycle taxis, public minibuses). For bottom-40% households spending approximately 15% of income on transport and 35% on food, a 10% second-round inflation shock on those categories translates to a 5% income erosion — roughly equivalent to scenario one, but arrived at through a different pathway.

In both cases, the conflict-driven oil shock layers onto an already strained household budget. The least-harm pathway depends on which margin has more capacity to absorb the shock: fiscal accounts that are tightening, or household budgets already stretched by 22% currency depreciation.

What the policy options are

Indonesia's options narrow as oil stays elevated and the rupiah remains under pressure:

  1. Maintain subsidies, tolerate fiscal widening. Accept the IDR 70 trillion overshoot and fund it through borrowing or reserve drawdown. This keeps household fuel costs stable in the near term but reduces the government's ability to intervene if the rupiah weakens further or if capital outflows accelerate. Sovereign borrowing costs rise when deficit projections widen, which can feed back into currency pressure.

  2. Adjust subsidies partially, share the burden. Lift retail prices by 10–15%, enough to halve the subsidy overrun but not enough to trigger acute household stress. Pair the adjustment with targeted cash transfers to the bottom 40%, funded by reallocating spending from less essential programs. This distributes the shock across fiscal accounts and household budgets rather than concentrating it in one place.

  3. Target subsidies more narrowly. Redirect subsidy support away from middle- and upper-income fuel consumers (private car owners) and toward public transport and logistics critical to food distribution. This reduces total subsidy cost without raising prices for the most import-sensitive households. Implementation requires administrative capacity Indonesia has not demonstrated at scale.

Bank Indonesia's scope for independent action is constrained. The central bank raised rates by 175 basis points between October 2025 and May 2026, yet the rupiah continued to weaken because capital outflows reflected global factors (Fed policy, risk-off sentiment) more than domestic rates. Further tightening risks slowing an economy already growing below trend. FX intervention can smooth volatility but cannot reverse a structural current account widening driven by higher oil imports.

What I am uncertain about

The duration and peak of the oil price shock remain unknown. If Middle East conflict de-escalates in the next 30 days and oil falls back toward $75 per barrel, the twin squeeze eases before it becomes a structural problem. If the conflict expands — closing the Strait of Hormuz even temporarily, or drawing in additional state actors — oil could reach $120 per barrel, and the fiscal and currency pressures sketched here would roughly double.

I do not have enough evidence to assess Indonesia's subsidy adjustment tolerance. The 2022 fuel price increase (roughly 30%) triggered protests but did not destabilize the government. Whether that threshold still holds in 2026, with household purchasing power already eroded by currency depreciation and inflation running above 4%, is a political judgment beyond the scope of currency and fiscal data.

The interaction between fiscal widening and sovereign risk perception is difficult to model precisely. A deficit that rises from 2.5% to 3% of GDP does not automatically trigger capital flight, but it may shift the marginal investor's calculation when Indonesia is already competing for flows against economies with tighter fiscal positions (Thailand, Malaysia). The threshold at which this becomes self-reinforcing — wider deficits raise borrowing costs, which widen deficits further — is not visible in advance.

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