MSCI's case against Indonesian stocks and the $65 billion fallout

JAKARTA, Oct 19 (Reuters) - Global index provider MSCI said last week it was considering downgrading Indonesia's stock market to "standalone" status from "emerging market", sparking a selloff that wiped about $65 billion in market value on the day of the announcement.

The announcement is the latest setback for Indonesian markets this year, after MSCI first flagged concerns in January over the investability of Indonesian equities. Jakarta responded by promising a raft of reforms to address those concerns.

WHAT ARE MSCI'S CONCERNS?

MSCI said last week that Jakarta had failed to make "sufficient progress" in demonstrating consistent implementation of market reforms and their sustained impact while weak enforcement remained a concern.

The index provider said in January its clients flagged problems around market data that obscured what proportion of Indonesian companies' shares could be freely traded and how the exchange categorised stock owners.

MSCI said its clients pointed to opaque shareholding structures and coordinated trading behaviour that undermined "proper price formation," suggesting prices of some Indonesian equities were being artificially supported, which raised questions about transparency, oversight and governance.

That meant Indonesia did not meet the requirements and standards of markets listed in the "emerging market" category, and could be downgraded to "frontier market."

WHAT HAS INDONESIA DONE SINCE THEN?

MSCI's initial warning in January led to mass resignations of top officials, who were replaced by figures widely known and trusted by markets.

Indonesia's financial regulator (OJK) then doubled the free float rule for listed firms to 15% from 7.5%, introduced tighter disclosure requirements for shareholders with at least a 1% holding and expanded the classification of shareholder types.

Minimum capital rules for securities firms and certain asset managers were also tightened to reduce the risk of market manipulation.

The stock exchange (IDX) released a list of stocks with high shareholder concentrations in April, in moves intended to shed light on potential coordinated trading.

Despite those moves, MSCI extended its review of Indonesia from June to November. A spate of fresh moves followed.

IDX said it would add 37 stocks to its list of companies with highly concentrated shareholdings, and in early October, it would adopt more reforms such as changing initial public offering rules by scrapping a minimum share price requirement to make shares more affordable and fundraising easier, in line with the earlier removal of a floor price for shares.

However, MSCI announced last week - a month before its scheduled review - that it was initiating a process to move Indonesia even lower than "frontier market" - that is, to "standalone" status.

WHAT IS INDONESIA DOING NOW?

Despite the announced reforms, MSCI said significant concerns remain around market dysfunction, including continued suspected coordinated trading behaviour and lack of evidence of meaningful enforcement.

Hours after MSCI's announcement last week, OJK handed down a total of 2.1 trillion rupiah ($116.41 million) in fines against entities involved in the trading of three companies' shares. The fines were linked to market manipulation practices.

Beyond the fines, Indonesian authorities have also got the police involved to investigate "alleged violations or criminal acts in the capital market." The police chief has promised "firm action" to ensure legal certainty in the capital market.

Authorities in Jakarta say they will speak to MSCI to clarify its concerns, which they say came as a shock. Jakarta has until April 30, 2027, to assuage MSCI's concerns and prevent a market reclassification. MSCI will announce its decision on or before June 30.

Meanwhile, to stem the selloff, IDX cut the exchange's daily limit for stock price declines to 7% from 15% to curb market volatility.

WHY IS MSCI CRITICAL FOR INDONESIA?

A shift to "standalone" status would risk cutting Southeast Asia's biggest economy off from international capital, relegating it to an investment backwater and clubbing it with a group of standalone markets that includes Lebanon and Zimbabwe.

The drop to "standalone" status would further pressure Indonesia's economy as the market lost about $60 billion on Friday alone, following MSCI's recent announcement. That figure shoots up to $350 billion in market valuation wiped out since January.

Jakarta's benchmark stocks .JKSE fell more than 5% on Monday after plummeting 11.6% on Friday - the highest single-day loss in nearly three decades - making the market the world's worst performer with a more than 40% drop so far this year.

The rupiah currency, which has also been under pressure due to a strong US dollar as well as investors' concerns over its fiscal risks, is already the worst-performing currency in the region, falling more than 7% so far this year.

($1 = 18,040.0000 rupiah)