In a move to curb the Indonesian rupiah's persistent decline and prevent further inflationary pressure from currency depreciation, Bank Indonesia unexpectedly raised interest rates on Tuesday.

The central bank increased its benchmark rate by 25 basis points to 5.5%, more than a week ahead of its next scheduled monetary policy meeting.

This follows a larger-than-expected 50 basis point hike in late May, bringing the total increase over the past three weeks to 75 basis points.

Bank Indonesia stated that the hike is a "follow-up measure to further strengthen the stability of the rupiah exchange rate" in response to heightened global market volatility stemming from the conflict in the Middle East.

It added that the action is also a "preemptive step to ensure inflation remains within the government's target range in 2026 and 2027."

The news provided some support to the currency, with the US dollar to rupiah rate retreating to 18,022.8 at the time of writing, having earlier hit a record high of 18,218.5.

Year-to-date, the rupiah has depreciated by nearly 8%.

This emergency action comes as investor concerns mount over Indonesia's fiscal spending plans and the president's economic agenda.

Simultaneously, efforts to defend the rupiah are depleting foreign exchange reserves, which have now fallen for a fifth consecutive month, marking the longest streak of declines since 2018.

This marks only the second time in roughly eight years that Governor Perry Warjiyo has raised rates outside of a scheduled meeting, the previous instance being in May 2018 in response to a sell-off in emerging market assets triggered by US rate hikes.

Following the surprise 50 basis point hike in late May, the rupiah initially strengthened but subsequently fell to new record lows.

Analyst Angus MacKintosh of Aletheia Capital noted, "To some extent, this has an air of desperation about it, but it should at least arrest the current slide."

OCBC economist Lavanya Venkateswaran stated, "While the hike may help prevent a further deterioration in market sentiment, its sustainability will still depend on whether clearer policy direction is provided to allay concerns over recent policy moves."

Following the emergency hike, economists at Barclays and strategists at PT Mega Capital Sekuritas indicated they expect Bank Indonesia to implement further tightening at its June 18 meeting, with another 50 basis point hike remaining a possible scenario.

Capital outflows are another key pressure point for the rupiah, with foreign investors having pulled over $3.5 billion from Indonesian equities this year, contributing to a more than 30% decline in the benchmark stock index.

Last Saturday, the central bank and government pledged to work together to enhance the appeal of Indonesian assets and attract more portfolio investment, but this failed to stem selling pressure which continued on Monday.

Bank Indonesia said on Tuesday it "sees the need to take further steps to strengthen rupiah stability by increasing yields and providing a number of incentives to attract foreign inflows."

These further measures reportedly include intensifying intervention in both onshore and offshore markets, increasing yields on rupiah-denominated securities, lowering the hedging swap rate by 10% to "compensate investors for the costs currently being borne," and re-launching repo auctions for banks with 3, 6, 9, and 12-month tenors to ensure sufficient liquidity in the money market and banking system.

Indonesia is not the only emerging market facing currency pressure.

Since late February, at least ten central banks in emerging and frontier markets, including those of Indonesia, Rwanda, South Africa, and Sri Lanka, have raised rates, moving faster than most developed-economy central banks which are still assessing economic impacts, as the Middle East conflict re-ignites global inflation concerns.

Beyond curbing inflation and supporting their currencies, preventing capital flight is another key reason for these rate hikes.

However, the effectiveness of such aggressive measures to prop up currencies has been limited.

The Head of Asia Strategy at SEB noted, "There is a limit to what central banks can do to support the exchange rate. The real problem is that these emerging markets are highly dependent on imported oil. Global energy supply and prices are not something central banks can control, so they are in a bind."