Middle East Conflict and Indonesia’s Macroeconomic Vulnerability: Exchange Rate, Inflation, and Fiscal Space Transmission Channels

Abstract

This study aims to develop a conceptual framework explaining how geopolitical risk from Middle East conflict is transmitted to the Indonesian economy through three main channels: the exchange rate, inflation, and fiscal space. A descriptive qualitative approach with a literature review design was employed. Relevant literature was identified through Scopus, Google Scholar, and SINTA-indexed national journals using keywords related to geopolitical risk, exchange rate pass-through, oil price shocks, fiscal space, and the State Budget (APBN). Sources were screened for thematic relevance, Indonesian context, academic quality, and substantive contribution. Analysis involved literature identification, thematic grouping, and conceptual synthesis. The review indicates that geopolitical risk transmission is neither linear nor uniform, with the three channels reinforcing one another. Holding administered energy prices down shifts pressure from consumer inflation to the State Budget; Rupiah depreciation may raise import costs and foreign currency liabilities; higher energy prices may intensify inflationary pressures and subsidy needs. Higher export commodity prices may generate additional revenues, so net effects depend on trade structure, external conditions, policy responses, and fiscal capacity. The study proposes an integrated framework linking the three transmission channels and identifies reinforcing and mitigating factors, addressing a gap in cohesive conceptualization of cross-country geopolitical shocks for Indonesia. The framework highlights the need for coordinated exchange rate, inflation, and fiscal policy responses, particularly regarding administered energy pricing and subsidy design. This research contributes a conceptual foundation for future empirical testing using VAR, SVAR, TVP-VAR, or nonlinear models with Indonesian data, supporting evidence-based policy analysis of geopolitical risk transmission.