The benchmark effect

GLOBAL index provider MSCI’s decision to keep Indonesia in its emerging markets (EMs) Index has temporarily erased some near-term stress across regional markets, but it has also prolonged uncertainty for investors.

And uncertainty is something that markets do not like.

MSCI which had earlier raised concerns over Indonesia’s market accessibility – especially with regards to the transparency of shareholding structures, free-float visibility, information flow and trading patterns – is expected to conduct another review in November.

This follows a broader set of market governance reforms by Jakarta’s Financial Services Authority and the Indonesia Stock Exchange aimed at curbing obscure proxy ownership structures and “murky” trading activities within the Indonesian equity market.

If MSCI is dissatisfied with the progress of South-East Asia’s largest equity market by November, it could downgrade Indonesia to frontier market status, forcing passive index-tracking funds to sell their holdings.

This could trigger massive capital outflows and currency pressure, with potential spillover effects across the region, including Malaysia.

In short, it boils down to one thing: strict enforcement.

Hong Leong Investment Bank (HLIB) Research tells clients that while the temporary move removes immediate downgrade risks, persistent rupiah weakness continues to pose translation headwinds for Malayan Banking Bhd (Maybank) and CIMB Group Holdings Bhd’s Indonesian operations.

“We estimate a manageable financial year 2026 (FY26) to FY28 earnings drag of 0.3% and 2.4%, respectively, partly cushioned by domestic net interest margin expansion and capital optimisation initiatives,” it says in a report.

It points out that Maybank and CIMB hold equity stakes of 79.9% and 92.5% as of June, in their respective local subsidiaries, PT Bank Maybank Indonesia Tbk and PT Bank CIMB Niaga Tbk.

“Previously, these operations remain peripheral to Maybank, accounting for approximately 3.3% of group profit before tax (PBT) while CIMB Niaga provides a more notable contribution to CIMB at about 5% of group PBT.

“Based on our earnings sensitivity analysis in our report dated Feb 16, every 1% depreciation in the rupiah against the ringgit results an estimated 0.3% reduction in CIMB’s consolidated bottom line,” says HLIB Research.

On the whole, it believes the Indonesian operating outlook for Maybank and CIMB remains clouded by execution risks and persistent rupiah translation volatility, both linked to domestic political uncertainties.

“However, defensive levers within other regional asset pockets are well-positioned to buffer these earnings shortfalls.

“Specifically, a stabilising Singapore Overnight Rate Average or Sora setting alongside structural domestic loan re-pricing should expand net interest margins ahead.”

How will it play out

An equity analyst with a local bank-backed brokerage tells StarBiz 7 that the outcome in November is likely to fall under three possible scenarios.

The first scenario is that Indonesia retains its EM status, which could occur if MSCI concludes that reforms have indeed improved market accessibility and investor confidence.

“Such an outcome would likely trigger relief buying in Indonesian shares and remove the immediate risk of forced selling,” he says.

“For Malaysia, this would also mean there would be no major MSCI-driven capital inflows, and Bursa Malaysia’s performance would then depend more heavily on domestic economic growth, corporate earnings and investment trends.”

The analyst notes that the retention of Indonesia’s status would not be negative for Malaysia, but it would mean Bursa Malaysia must compete based on fundamentals rather than index reallocation.

The second scenario is an Indonesian downgrade to frontier market status, which would have a larger market impact.

“Passive funds tracking EM benchmarks would likely need to cut their Indonesian holdings, resulting in potential capital flows into other eligible EMs.

“Malaysia is a natural beneficiary because of its accessibility and, to a certain extent, liquidity and solid institutional investor base,” says the analyst.

He says banking counters, consumer companies and technology-related stocks could attract attention from investors seeking exposure in this part of the world.

The third scenario is a continuation of the review.

“In this case, if MSCI believes Indonesia is making progress but requires more time to assess the effectiveness of its reforms, it may postpone its final decision to a later date, thus once again, prolonging uncertainty.

“If this happens, Indonesia would possibly remain under scrutiny, while Malaysia could benefit from selective foreign inflows rather than a major one-off capital shift.”

Interestingly, a notable contrast to Indonesia’s stock market story is Vietnam’s.

Simultaneously, Indonesia was informed by MSCI that it could temporarily retain its EM status, Vietnam was told to retain its current classification as a frontier market.

The Vietnamese market, however, is hoping for an upgrade to EM status in the near future.

What can be clearly gleaned from these two market examples is that investors are not only interested in a country’s economic growth trajectory.

Factors such as governance, transparency and market accessibility are becoming increasingly non-negotiable.

“Global capital will continue to chase these factors, and not merely growth alone,” says the analyst.

Back in Indonesia, investors will closely monitor the implementation of reforms, foreign fund flows, market liquidity and corporate disclosure standards ahead of the November review.

Notably, MSCI has indicated that reforms must demonstrate consistency and effectiveness.

The November review will be significant not only for Indonesia but also for the broader Asean investment landscape.

A downgrade could accelerate capital rotation towards Malaysia, but it would remain negative for Malaysian companies with significant exposure to Indonesia.

Conversely, successful Indonesian reforms would likely intensify competition for foreign investment flows.

Malaysia’s challenge will be to convert any potential increase in investor interest into long-term capital commitments by delivering consistent economic growth, stronger corporate earnings and a stable political environment.