Indonesia faces an investor exodus

INDONESIA’S battle to remain in global emerging-market (EM) indexes could have consequences well beyond its stock market, with a possible exclusion threatening to divert billions of dollars in foreign investment and make financing more difficult for businesses and the government.

The country now faces a crucial test – whether it can convince global investors that its market is transparent and reliable enough to retain its place in the benchmarks that help direct international capital.

According to a recent Reuters analysis, the risk of being removed altogether from MSCI’s global stock indexes has raised concerns about Indonesia’s access to funding, its currency and the broader economy.

The proposal is particularly striking for South-East Asia’s biggest economy, which has been classified as an EM by MSCI since 1989. Indonesia was previously a foreign investor favourite, but concerns over opaque share ownership and trading practices have put that standing at risk.

MSCI had initially considered a less severe downgrade to frontier-market status. Its latest proposal to move Indonesia to standalone status, however, would place it outside both EM and frontier-market classifications, alongside a small group of markets that includes Lebanon and Zimbabwe.

Such action has few precedents. Argentina was removed from MSCI’s indexes in 2021 after imposing capital controls, while Russia was excluded in 2022 after Western sanctions following its invasion of Ukraine cut it off from global finance.

“The proposal...goes well beyond what we had considered our worst-case scenario,” Rully Arya Wisnubroto, head of research at Mirae Asset Sekuritas in Jakarta, told Reuters.

Accelerated outflows

The negative market reaction showed how quickly the threat could translate into financial losses. MSCI’s announcement last Friday wiped about US$65bil off the value of Indonesian equities, sending the Jakarta Composite Index down 11.6% in its biggest one-day fall since the Asian financial crisis in 1998.

The rupiah also weakened by as much as 0.8%, prompting concerns that the pressure could spread from shares into the bond market.

Some analysts raised the possibility of an interest rate increase by Bank Indonesia to discourage further capital outflows, even though rates had been expected to remain unchanged.

“The purpose (of a rate hike) would be pre-emptive, that is, in order to prevent the expected equity foreign outflows from widening to the fixed income side as well as being exacerbated by resident capital outflows,” Citi wrote in a note to clients.

The potential outflows are significant because MSCI’s indexes are widely used by investment funds to determine where their money goes. More than US$1.8 trillion in assets are benchmarked to the provider’s EM indexes, according to its website.

Banks estimate that Indonesia’s removal could trigger US$3bil to US$6bil in passive investment outflows. JPMorgan puts the potential withdrawals at US$4.8bil, while UBS has warned that active investors could pull another US$15bil.

The distinction between a frontier-market downgrade and outright exclusion matters. A move to frontier status could attract fresh demand from funds tracking those markets. Standalone classification, by contrast, would leave Indonesia without that potential source of buying, as EM index funds adjust their holdings.

Indonesia’s shrinking weight in MSCI’s EM indexes does not eliminate the risk. Its weighting has fallen from 1.2% at the end of 2025 to 0.46% currently, according to JPMorgan.

Argentina’s weighting was only 0.12% when it was removed, highlighting the potentially greater scale of Indonesia’s exclusion.

“Is Indonesia really on par with Zimbabwe in market behaviour and structure? Is shareholder treatment really worse than in many other EM markets, including several in Asia?” Juan Torres, co-manager of the Neuberger Emerging Markets Equity fund, was quoted as saying by Reuters.

Managing risks

The consequences could extend into corporate financing and government spending. If foreign investors become less willing to provide capital, state-linked companies could find it harder or more expensive to raise funds.

Citi analysts said this could force the government to absorb spending obligations itself or scale back investment.

“We expect the broader economic impact to be predominantly indirect, with external financing representing the most immediate transmission channel,” Irman Faiz, economist at Bank Danamon Indonesia in Jakarta, told Reuters.

That exposure matters for an economy that is a major global supplier of thermal coal, palm oil and nickel, as well as copper and coffee. Indonesia has benefitted from higher prices for some of its main commodity exports this year, but its position as a net oil importer has also left it facing rising import bills.

For now, the immediate challenge is to address MSCI’s concerns before its review concludes.

The index provider has cited opaque ownership structures, suspected coordinated trading and inadequate enforcement, arguing that these problems make it difficult for investors to establish companies’ true free float and rely on market prices.

Indonesian authorities have spent much of the year trying to improve disclosure requirements and have outlined plans to raise minimum free-float levels. On Oct 17, the regulator also announced sanctions linked to alleged manipulation involving three stocks.

MSCI’s consultation is due to run until April 2027, with a final decision expected by June. The provider expects the downgrade to proceed unless it finds clear evidence of improvements in governance and market functioning.

Indonesia’s deputy coordinating minister for economic affairs Dradjad Hari Wibowo acknowledged the importance of MSCI’s assessment while questioning whether its judgement should be accepted without challenge.

“It’s true that MSCI has a strong reputation, and it’s also true that we need to pay attention to what they say,” he told Reuters. “But there’s one thing I want to emphasise – they (MSCI) aren’t always right,” he added.