Indonesia awaits MSCI verdict that risks US$13bil outflows

The Jakarta Composite Index has slid nearly 31% this year on concerns over the decision and economic management under President Prabowo Subianto. (EPA Images pic)

JAKARTA: Indonesia faces a crucial test this month when MSCI Inc decides whether to follow through with a downgrade, with investors already questioning the resilience of the world’s worst-performing equity market.

Should the index compiler reclassify Indonesia as a frontier market, instead of emerging, some analysts say global funds could withdraw as much as US$13 billion in outflows.

It would also further pressure the benchmark Jakarta Composite Index, which has fallen nearly 31% this year on worries about the decision coupled with concerns over economic management under President Prabowo Subianto.

The decision is becoming more critical after a multi-day selloff across Indonesian assets in recent days raised concerns over foreign outflows nearing US$4 billion from stocks this year. Keeping its EM status – the base case for most investors – would help some restore confidence and give Prabowo some breathing room to revive growth.

“There’s already progress in improving transparency, although nobody knows if that’ll be enough for MSCI,” said Albert Budiman, chief investment officer at UOB Asset Management Indonesia.

It’s not clear whether averting a downgrade would resolve all of Indonesia’s challenges. The rupiah faces multiple headwinds – from elevated oil prices to a widening budget deficit – pushing it to successive record lows.

Rising state intervention in commodity exports, alongside a corruption probe into the former head of Prabowo’s flagship free meals programme, has also unsettled investors.

Analysts say several scenarios could happen. MSCI could retain Indonesia’s status after removing a number of highly concentrated stocks from its gauges in May. It could also opt to keep the market under review, leaving regulators on the hook for continued scrutiny over trading irregularities.

In a worst-case scenario, MSCI could downgrade what was once Southeast Asia’s largest market to frontier status, placing it alongside peers like Vietnam and Bangladesh.

A downgrade would be “very bad news” with capital flowing back into emerging markets for the first time in years while allocations to frontier remain far more limited, said Jean-Louis Nakamura, head of conviction equities at Vontobel Asset Management, which oversees about US$300 billion.

A reclassification could trigger similar moves by FTSE Russell and S&P Dow Jones Indices, a devastating outcome that may spur a long process for Indonesia to reclaim its emerging-market status. FTSE said last month it would delay re-ranking Indonesia, including changes to free float and stock additions, until at least its September review to allow for further monitoring.

Despite these concerns, some strategists say the longer-term investment case remains intact.

“Amid these various concerns, investors also need to remember that the long-term view of Indonesia has not entirely changed,” said Liza Camelia Suryanata, head of research at PT Kiwoom Sekuritas Indonesia. The country still retains its advantages in the form of a large economic size, abundant natural resources, and a vast domestic market, she added.

That longer-term case has also shaped the policy response, with officials rolling out a series of measures in recent months aimed at boosting liquidity, improving transparency and widening access for foreign investors. The naming of nine firms with high shareholder concentration also helped bolster confidence.