Indonesia’s $1.5 trillion market faces a historic downgrade: Why global investors are worried

ETMarkets.com

The rupiah also weakened sharply to 18,070 per dollar, its lowest level since late July and close to its lifetime low of 18,190.

The selloff extended across the country’s biggest banks. Bank Central Asia, Bank Rakyat Indonesia and Bank Mandiri each fell nearly 15%. With Friday’s losses, Indonesian equities have declined nearly 40% in 2026, making them the world’s worst performing stock market.

Why MSCI’s warning matters

MSCI said it would put Indonesia on a path toward “standalone market” status, a classification worse than the previously threatened frontier market downgrade. The index provider also proposed removing Indonesia from a suite of products tracked by global investors.

A standalone classification would exclude Indonesian stocks from global indexes followed by billions of dollars in passive investments. Funds that track, or are benchmarked against, those indexes could then be required to sell Indonesian securities.

Indonesia would join Argentina, Lebanon, Palestine and Ukraine in the standalone category, becoming the only Asia-Pacific market with that classification. At $1.5 trillion, it would also be the largest economy in the group, more than twice the size of Argentina which is the next largest economy.

The risk is therefore not limited to a change in market labels. A downgrade could alter how global funds allocate capital to Indonesian stocks, adding pressure to an equity market already hit by concerns over transparency, regulation and policy credibility.

The concerns behind the downgrade

MSCI’s concerns centre on the functioning of Indonesia’s equity market. In January, the index provider warned that it could downgrade Indonesia to frontier-market status. It cited opaque shareholding structures and coordinated trading behaviour that it said had undermined “proper price formation”.

MSCI also said market data made it difficult to determine what proportion of company shares was freely tradable and how different categories of stock owners should be classified.

On Oct. 16, MSCI said feedback from market participants suggested that even a reclassification to frontier-market status “would not properly recognise the depth of the market problems”.

That assessment escalated the threat from a conventional downgrade to a possible move into the standalone category.

“Indonesia’s immediate priority should be to demonstrate measurable improvements in market transparency and regulatory enforcement rather than merely announcing additional reforms,” said Josua Pardede, chief economist at Bank Permata.

“Preventing a downgrade would be an important near-term achievement, but the more fundamental objective should be rebuilding Indonesia’s credibility as a transparent, well-regulated, and reliable destination for long-term international investment.”

MSCI’s latest warning follows a series of setbacks for Indonesia’s capital markets and policymakers. The index provider’s initial warning in January triggered a $120 billion equity selloff and prompted several senior Indonesian regulators to resign, including the head of the stock exchange. Financial authorities subsequently promised major reforms.

Later in January, Goldman Sachs downgraded Indonesian equities to underweight and estimated that foreign investment outflows could reach $7.8 billion if MSCI proceeded with a downgrade, although it considered that outcome unlikely at the time.

Moody’s subsequently cut Indonesia’s credit-rating outlook to negative from stable while retaining its Baa2 rating. The ratings agency cited reduced predictability in policymaking, risks to policy effectiveness and signs of weakening governance.

Moody’s also lowered the outlook for companies including Telkom Indonesia, Indofood CBP Sukses Makmur and United Tractors.

Fitch followed in March by cutting Indonesia’s sovereign rating outlook to negative from stable, citing greater uncertainty and reduced credibility in policymaking.

MSCI then removed six companies from its Indonesia index in May over continuing concerns about ownership and trading transparency.

The index provider had been expected to conclude its Indonesia review in July but deferred it to November, saying a downgrade remained possible. The review has now been extended to June 2027.

FTSE Russell also said in May that it would remove Indonesian shares with high shareholding concentration, effective June 22. It had earlier postponed its own review of Indonesia, citing concerns similar to those raised by MSCI over the difficulty of determining freely tradable stock.

Exchange pushes back

The Indonesia Stock Exchange said MSCI had asked about the effectiveness of the exchange’s reforms during their meeting earlier this week, but had not mentioned a downgrade to standalone status, according to an official.

The exchange said it would soon communicate with MSCI and provide stronger evidence of its reforms.

Indonesian listed companies are fundamentally sound and remain solid, the exchange said, adding that the issue was a matter of perception.

Indonesia’s market troubles have also been compounded by uncertainty around economic policymaking. The resignation of central bank governor Perry Warjiyo in July, midway through his second five-year term, weighed on Indonesian assets and prompted calls from the government for calm.

The sequence of events has reinforced investor concerns over policy predictability at a time when the country is trying to defend its position in global equity benchmarks.

A standalone classification would make Indonesia an outlier in Asia Pacific and could deepen the pressure on the rupiah and domestic equities. For now, the Indonesia Stock Exchange is seeking to persuade MSCI that its reforms are producing measurable improvements.

But as Pardede noted, preventing the downgrade would only address the immediate threat. The larger challenge is restoring Indonesia’s credibility as a transparent, well-regulated and dependable destination for long-term international capital.