Reserve manager: Bank Indonesia

Bank Indonesia has taken a far more nimble approach to reserves management after the Federal Reserve began raising interest rates in 2022. It has adopted a more flexible approach to managing the country’s foreign exchange reserves that enabled it to adapt faster to change, while also supporting monetary operations. The central bank now reviews its assumptions and updates its strategic asset allocation (SAA) framework much more regularly. It uses information from trading offices around the world to inform its reserve positions while keeping environmental social and governance (ESG) goals in mind.

The inflation genie escapes the bottle

Before the Covid-19 pandemic, Bank Indonesia focused on maximising returns, which was difficult in the era of low interest rates and flat yields. It had to use all the risk-adjusted return optimisation frameworks at its disposal.

But when the Federal Reserve began raising interest rates in 2022, in response to the wave of global inflation, Bank Indonesia saw yields spike – along with domestic inflation. The rapid rise in global interest rates and uncertainty in 2022 presented Indonesia’s central bank with two challenges: supporting monetary policy at a time when foreign investors began repatriating their capital; and protecting the market value of its FX reserves, which were declining rapidly on paper due to negative mark-to-market valuations on fixed income securities.

The bank shifted focus from the pre-Covid era of returns maximisation to safeguarding asset value and protecting the rupiah. Bank Indonesia had to ensure it had ample liquidity to finance its monetary operations and manage the exchange rate while limiting downside risks. Notably, it introduced a conditional value-at-risk approach to risk in the beginning of 2023, shifting from a traditional mean-variance approach, to limit downside market risks caused by extreme events.

The bank built on the IMF’s assessing reserves adequacy framework by establishing three levels that it determines as ‘minimum reserve adequacy’, ‘required reserve adequacy’ and ‘enhanced reserve adequacy’ (ERA). The bank’s reserves currently stand above its ERA, the highest threshold.

Having ample reserves meant Bank Indonesia was comfortable issuing a dollar-denominated bill as part of its monetary policy strategy to enhance the effectiveness of monetary policy transmission, accelerate the deepening of money and FX markets, and encourage capital inflows. The outstanding bills total around $2.7 billion today.

Short, agile and focused on the SAA

Before the introduction of the new reserve management framework, it was quite difficult to adjust portfolio duration due to several constraints. With the new framework, invesment managers have more flexibility to rebalance portfolio duration aligned with market dynamics. Due to higher interest rates, Bank Indonesia was able to shorten duration for internally and externally managed portfolio to preserve value. It also added more dollar-denominated assets, which have offered higher yields than most of their non-dollar counterparts.

For its internal management, the bank effectively scrapped the use of a benchmark as amendments took too long. Rapidly moving market prices required the central bank to move quicker or to pre-empt certain situations. News and rumours about possible Fed cuts were immediately responded to with a slight increase in the duration of its bonds. But Bank Indonesia quickly reversed this as the situation developed and continued Fed cuts seemed more unlikely. This was possible due to the close coordination between Bank Indonesia Jakarta office and its sub dealing rooms in New York, London and Singapore. Since Bank Indonesia recognised the market “overreacted” after the initial Fed cut in September and bond yields dropped too much, it stopped extending its bond maturities and reversed course, which paid off, especially after the spectre of inflation returned in the shadow of the newly elected Trump administration.

“In this situation we need to be agile; we need to react fast, to anticipate the situation,” Rahmatullah Sjamsudin, executive director of Bank Indonesia’s reserve management, tells Central Banking. Bank Indonesia recognised the market was “overactive” after the initial Fed cut in September and bond yields dropped too much – so it stopped extending its bond maturities and reversed course, which paid off, especially after the spectre of inflation returned in the shadow of the newly elected Trump administration.

Using its new framework, Bank Indonesia reviews its strategic asset allocation periodically and has the flexibility to adjust its strategic asset allocation to respond to the market changes quickly. If the reserve managers notice one or more of their assumptions are not being met, they can quickly propose changing the SAA and pivot. For example, when problems started percolating in one country’s housing market, the department took notice of that currency coming under pressure, so it formulated a new SAA – and proposed a reduction in its holdings of that particular currency.

Bank Indonesia also strengthened the FX reserve management’s governance by updating the FX reserve outstanding to the board of governors regularly. The report and its projection will also be updated for the monthly board meeting purpose.

Repos and securities lending

Bank Indonesia is active in repos for two purposes: for liquidity, it can repo assets with commercial banks for cash; and, when its office in New York signals there is market interest in specific issues or securities, it can lend those assets for return enhancement, picking up several basis points.

To diversify its US dollar assets and for return enhancement, the bank also added more to its mortgage-backed securities portfolio, which it began managing in-house – as it does for its securities lending operation. Managing the securities lending means Bank Indonesia can squeeze a slightly bigger margin out of lending operations than peer central banks that employ external parties.

Bank Indonesia continues to use benchmarks for external managers but updates them regularly. For example, when regional banks failed in the US in 2023, the bank updated its benchmark to prevent further investment in these lenders. It also moved some investment out from emerging economies and technological advancements.

Bank Indonesia has a multi-pronged approach to ESG-related investment.

This includes the implementation of exclusionary/negative screening of its corporate bond portfolio and benchmark managed by external portfolio managers. It also applies a socially responsible investing filter in the benchmark and portfolio in the areas of adult entertainment, alcohol, gambling, tobacco, conventional weapons, civilian firearms, nuclear weapons, controversial weapons, nuclear power, thermal coal, fossil fuels and genetically modified organisms.

It also invests in green social sustainability bonds and is actively participating in international financial cooperation that promotes sustainable investment through investing in thematic funds such as BISIP G3 (the Bank for International Settlement’s Asia green bond fund), focusing on specialised areas like green bonds and regional financial markets.

The challenge for Bank Indonesia in implementing sustainable investing lies in balancing the still-developing policy framework and liquidity needs as well as its strategy of shortening investment durations. Nonetheless, Bank Indonesia continues to expand its sustainable investment holdings.

As it heads into 2025, Bank Indonesia, thanks to its trading offices in Singapore, London and New York, continues to “operate 24 hours a day”, says Rahmatullah. To facilitate this, the reserve management department developed internal system information to connect portfolio managers from the Jakarta, New York, Singapore and London offices digitally to discuss issues, update assessments and brainstorm ideas.

In its view, there is a need to monitor everything and adjust strategy continuously. With the new US administration – and the fires of inflation being stoked by Trump’s proposed protectionist policies – everything needs to be monitored closely. The reserve management department gathers daily to discuss the market conditions, checks its SAA against its assumptions and, if required, update it.

The agility and fluidity of its operations sets the Asian central bank apart from its peers, and its reserve department believes that more central banks should take a similar view. “You can’t afford to have the traditional approach anymore,” Rahmatullah says. “Updating the SAA every three to five years puts central banks behind the curve and risks eroding their reserves and capabilities.”

The Central Banking Awards 2025 were written by Christopher Jeffery, Daniel Hinge, Daniel Blackburn, Joasia Popowicz, Riley Steward, Jimmy Choi, Levente Koroes, Thomas Chow and Blake Evans-Pritchard.