Indonesia faces possible cut to frontier market by S&P Dow Jones

JAKARTA: Indonesia’s efforts to reassure global investors suffered another setback after S&P Dow Jones Indices signalled the country could eventually lose its emerging-market status if concerns over its stock market persist.

The move is likely to deepen skepticism over whether recent reforms have gone far enough to address long-standing investor complaints about transparency, liquidity and the limited amount of shares available for trading in some of Indonesia’s largest companies.

In its annual update, S&P DJI on Wednesday placed Indonesia on a list of markets facing possible reclassification, saying it may first introduce special treatment for Indonesian securities if circumstances worsen.

A downgrade would not be imminent, however, as any review of the country’s status would only take place if the issues remain unresolved one calendar year from the date of introduction of the special measures.

The move will likely add to investor uncertainty that’s brewed over months after MSCI Inc in January raised concerns about Indonesian stocks’ investability and flagged a potential downgrade to frontier market status.

Concerns in particular around free float have emerged as a flashpoint in Indonesia in recent years, as investors lament that the nation’s biggest companies are thinly traded and controlled by a handful of wealthy individuals.

“If Indonesia gets downgraded and does not heed what the index providers are saying, we are talking about billions of dollars of outflows,” said Ashwin Binwani, founder of Alpha Binwani Capital.

Indonesia is increasingly being seen by investors as a market where policy uncertainty, political intervention, and execution risks are eclipsing one of the developing world’s most compelling long-term growth narratives – a perception that has intensified since president Prabowo Subianto took office less than two years ago.

MSCI’s warning, which had triggered a market rout, prompted authorities to introduce a series of reforms. The index compiler last month postponed its review on Indonesian equities, already delayed from May, saying it needed more time to see whether recently announced transparency reforms are effective.

FTSE Russell said in May 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.

S&P DJI’s warning piles more pressure on Indonesian authorities to accelerate reform initiatives, though its one-year runway before any reclassification gives the country more breathing room, according to Fabien Yip, market analyst at IG International.

“S&P DJI’s emerging market benchmarks also carry far less passive assets under management than MSCI’s. So the flow risk from this specific announcement is relatively lower,” Yip said.

Regulators have introduced a series of reforms in recent months, including raising minimum float. The Indonesia Stock Exchange took the unusual step of identifying firms with high shareholder concentration – an issue that underpinned MSCI’s decision to remove some of these stocks from its indexes in May.

The installation of capital markets veteran Jeffrey Hendrik as chief executive officer of the stock exchange recently has also steadied some nerves.

Uncertainty ahead of the index compilers’ decisions had pushed many market participants to the sidelines, with investors citing the overhang from potential outflows.

The benchmark Jakarta Composite Index has tumbled 31% to become the world’s worst-performing major gauge this year. The rupiah is also among the weakest emerging market currencies, down more than 7% against the US dollar.

While S&P DJI’s reclassification threat only adds to an existing risk, it is likely to weigh on investor sentiment, said Wee Khoon Chong, senior Asia Pacific market strategist at BNY.

“It is negative for sentiment and is likely to add downside pressure on Indonesian stocks, or reignite further waves of outflows from Indonesia,” Chong said.