Indonesia's stock market has been collapsing rapidly after a "warning on investment eligibility" from the global index provider MSCI (Morgan Stanley Capital International). The Jakarta Composite Index, the benchmark, has plunged more than 8% over the past two days.
About $80 billion (about 115 trillion won) in market capitalization has been wiped out in the process. As the losses mounted, there were even moments when trading was halted during the session. Observers say Indonesia, once considered Southeast Asia's representative emerging market, is facing its most serious credibility crisis since the 1998 Asian financial crisis.
On Jan. 30, major outlets including Bloomberg and Reuters said, "Foreign outflows are accelerating after MSCI issued an official warning on the investment eligibility of Indonesia's stock market." Reuters said the move could lead to large-scale "rules-based selling" if it results in a downgrade in emerging market indexes. Bloomberg called it a "crisis of confidence that shook Indonesia's stock market across the board."
This situation is a warning not about a single corporation's bad news but about the national market as a whole. MSCI is a key index used as a benchmark when pension funds and large asset managers worldwide set country allocations. Global institutions that manage trillions of won determine investable countries and weights based on this index. As a result, if MSCI raises issues with a particular country's securities market structure, that country can immediately fall out of favor as an investment destination.
MSCI recently said there are "material deficiencies" in stock-related information provided by the body overseeing Indonesia's stock market. It specifically pointed out that data on the portion of listed shares that are freely tradable in the market, the so-called free-float ratio, differs from reality. This figure is the most basic indicator foreign investors use to set buy and sell strategies. If information is opaque, it is hard to judge whether transactions of the desired size can be executed at the desired time. Experts said the larger the institution and the funds it runs, the more sensitively it reacts to such uncertainty.
MSCI has suspended all additions and deletions of Indonesian corporations in its indexes until the issue is resolved. It also warned that unless clear remedies emerge by the regular review in May, Indonesia could be downgraded from the Emerging Market (EM) index to the Frontier Market (FM).
In financial circles, the shift is likened to "dropping from the first division to the second division." The emerging market index is where global pension funds and large funds invest by default. By contrast, the frontier index is often subject to limits on allocation due to high volatility. If a downgrade materializes, funds that automatically track the MSCI Emerging Markets index will be required by rules to sell Indonesian stocks. The market projects that as much as $13 billion (about 18 trillion won) could flow out at once in that case.
In reality, the market is already pricing in a "downgrade scenario." The Jakarta Composite Index plunged 9.8% from a peak of 9,135 on Jan. 20 to 8,232 on the 29th. The steepest losses were concentrated in the past two days, rapidly chilling sentiment. Bloomberg said some names suffered such a lack of liquidity that sell orders piled up and prices failed to form properly.
Global investment banks are also lowering their views on Indonesian equities. Goldman Sachs recently cut its recommendation on Indonesian stocks to "underweight." Goldman Sachs said, "The issues raised by MSCI are not a short-term event but a structural risk that constrains market performance," adding, "They could become a long-term factor blocking foreign inflows."
The biggest concern for investors is the transparency of corporate governance. Among investors, suspicions are growing that even if the number of shares circulating in the market appears sufficient on the surface, controlling shareholders or affiliates limited the supply available to retail investors by splitting up equity holdings.
Uncertainty in Indonesia's politics and macro variables also added to the jitters. The market focused on the recent departure of Minister Sri Mulyani Indrawati, who had earned trust as an "economic fixer." Indrawati had emphasized a policy stance prioritizing fiscal soundness. After she was ousted, concerns spread among foreign investors that this policy stance could be shaken, further eroding confidence. On top of that, the weakness of Indonesia's currency, the rupiah, fueled talk of a widening fiscal deficit. The view that the Central Bank's independence could come under political pressure also hurt sentiment.
Indonesia's financial authorities, alarmed, belatedly rolled out damage control. The Financial Services Authority (OJK) announced it would double the minimum free-float ratio that listed companies must maintain, from the current 7.5% to 15%. The intent is to boost the amount of stock actually transacted in the market and overcome the transparency issues MSCI flagged. Financial Services Authority Chairman Mahendra Siregar said, "We will implement the new rules swiftly and consider strong measures, including delisting, for corporations that fail to comply."
The market response remains tepid. Franklin Templeton portfolio manager Yiping Liao said, "With structural issues unresolved, there is no reason for foreign investors to rush back," adding, "With plenty of alternative destinations, there is no need to take unnecessary risks."