Indonesian stock market crash: What happened?

Indonesia's stock market experienced a sharp sell-off on Wednesday, with the benchmark Jakarta Composite Index closing down 7.4%, marking the largest single-day drop in over nine months. This followed an announcement from MSCI that adjustments to some indexes, including the addition of new constituents, would be suspended immediately until regulators resolve the issue of excessively concentrated company shareholdings.

In its statement, MSCI noted that the Indonesian market has long faced structural issues such as a low proportion of freely traded shares, minority shareholders controlling large stakes, and insufficient liquidity. The company warned that if Indonesia fails to make significant progress in market transparency and regulation before May, its status in the Emerging Market Index could be reassessed and may even face a downgrade to "Frontier Market" status.

Affected by the news, the Jakarta Composite Index plunged as much as 8.8% during Wednesday trading, triggering a pause mechanism. Stocks expected to be included in MSCI's index took a severe hit, with several hitting their daily limit down. Foreign capital has shown signs of exiting: as of the week ending January 23, global investors had a net sale of $192 million worth of Indonesian stocks, ending a previous streak of 16 consecutive weeks of net inflows. On Wednesday morning, the Indonesia Stock Exchange recorded a net outflow of about IDR 3 trillion (approximately $180 million).

MSCI Issues "Warning Shot"

Tareck Horchani, head of institutional brokerage at Maybank Securities Singapore, commented:

"MSCI's freeze decision is more of a warning signal rather than a final verdict. The market has already begun pricing in potential negative outcomes, which explains the selling pressure on Indonesia’s index heavyweight stocks."

MSCI made this decision after months of market consultation. Previously, the company proposed tightening standards for assessing the proportion of Indonesian securities' freely traded shares and considered using alternative data from the Indonesian Central Securities Depository (KSEI) to more accurately evaluate actual tradable shares. If a company's actual proportion of freely traded shares is lower than reported, passive funds tracking the relevant indexes would be forced to reduce their holdings.

I Gede Nyoman Yetna, head of listing at the Indonesia Stock Exchange, said Wednesday that the exchange is committed to responding to MSCI's call for increased transparency and will cooperate with MSCI to seek consensus. The exchange also plans to consult market participants on a reasonable level for free float ratios and will work with KSEI to provide clearer shareholder structure classification data.

Free Float Issue Remains a Lingering Problem

The proportion of freely traded shares has become a focal issue in Indonesia’s stock market. Last year, the Jakarta Composite Index outperformed the MSCI Indonesia Index by a record margin, highlighting the price divergence and concerns over liquidity mismatches. Due to thin trading in many MSCI Indonesia Index constituents, several passive fund managers reported that the benchmark index is, in practice, difficult to track effectively, prompting a move towards the stricter MSCI Emerging Markets Index.

Indonesian regulators have begun addressing related issues, planning to gradually raise the minimum free float requirement from the current 7.5% to 10-15%, with a long-term goal of 25%; however, there is currently no clear timetable. For comparison, the minimum free float requirement is 25% in Hong Kong and India, and 15% in Thailand.

Yiping Liao, portfolio manager at Franklin Templeton Global, noted:

"If Indonesia is ultimately downgraded, the impact on passive fund outflows would be huge. In fact, due to macro environment and policy uncertainty, foreign participation in the Indonesian market has already declined significantly."

Policy Uncertainty Intensifies Investor Concerns

MSCI's decision may further intensify market concerns about Indonesia's economic development path. President Prabowo Subianto is seeking to achieve his economic growth goals through fiscal and monetary policy guidance, but investor confidence remains fragile. The dismissal last year of longtime Finance Minister Sri Mulyani Indrawati and Prabowo’s increased influence over the central bank have already unsettled the market.

Coordinating Minister for Economic Affairs Airlangga Hartarto said he would meet with financial regulators on Thursday to discuss MSCI's requirements, and noted that Indonesia could learn from mechanisms implemented in other countries to improve transparency at the local exchange.

John Foo, founder of Valverde Investment Partners, commented:

"The risk is that Indonesia does not do enough. If downgraded to frontier market, it could trigger panic selling. We are underweight on Indonesia, with almost zero exposure."

Since the beginning of this year, Indonesia’s stock market has lagged behind other Southeast Asian countries. Prior to Wednesday's plunge, the Jakarta Composite Index was up only 2.7% for the year, while the MSCI ASEAN Index surged 5.3% in the same period.

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