Indonesia’s benchmark stock index, the Jakarta Composite, fell 11.6% on October 16, its worst day since 1998, after MSCI proposed reclassifying the country from emerging to “standalone” status, skipping frontier. A final decision is due by June 30, 2027. If MSCI follows through, Indonesian stocks would leave its emerging-market indexes, and the passive funds that track them would be forced to sell, whether or not the underlying businesses have changed. That is the pitfall of indexing: a verdict on a whole market gets applied to every company in it, including the good ones.
Here is a quick sit-down with Bin Xiao, Polaris portfolio manager, on what he thinks is and isn’t broken in Indonesia and what the episode shows about active investing in emerging markets.
It puts pressure on the biggest, most liquid stocks, because that’s where the money has to come out. Foreign investors have already net sold close to $5 billion this year – that’s investors choosing to sell. Index funds have no choice, and they only sell after MSCI’s final decision and an effective date, which isn’t set. Estimates run from about $3 billion to $5.6 billion, and most of it falls on the largest stocks left in MSCI’s main Indonesia index.
Some of that pressure is fair, because weak governance can raise the cost of capital for every company in a market, but prices can overshoot.
It’s a real step, but I wouldn’t assume it’s enough. The exchange and government rolled out reforms after MSCI’s January warning, and MSCI still wasn’t satisfied. Now it’s proposing a double downgrade, from emerging all the way to standalone, so even with the government cooperating, MSCI came back with something more severe. It points to opaque shareholding, suspected coordinated trading and weak enforcement, and the exchange is now going after concentrated ownership too.
You can see the government trying. The market rebounded more than 5% on October 20, though it’s still close to a six-year low. What matters now is whether they follow through. MSCI says it expects to proceed unless it sees clear evidence of material improvement during the consultation.
Start with the country. This downgrade has little to do with Indonesia’s growth story. You have close to 290 million people, an economy still early in its development, and natural resources, so there’s a lot of room to grow. You also have large, liquid companies that have long been a favorite play for investors. MSCI’s concerns apply to the whole market, but in my view the worst of it sits in tightly held conglomerates, and several of those, like Chandra Asri and Barito Renewables, are already out of its Indonesia index. I don’t think the large banks and the telecom are the target of the criticism, and I don’t see the downgrade changing their fundamentals. It would sweep them up anyway.
When I look at the growth, the quality and the valuation, these look like “the babies” to me. They fell more than the market because they’re the biggest, most liquid stocks, so they’re the easiest to sell. We own two of the banks, Bank Rakyat Indonesia and Bank Central Asia. At Bank Rakyat, the fundamentals are improving: in the first half, loans grew 16%, profit rose 17.5%, and funding and credit costs came down. Bank Central Asia is also growing, but more slowly. After the sell-off, both traded below their long-term averages.
MSCI is only part of it. The bigger issue, in my view, is fiscal policy: big new spending programs that widen the deficit. The market clearly doesn’t like that, and it’s a big reason the currency is weak and borrowing costs are up, along with higher oil prices.
I watch the currency first. A weaker rupiah and higher borrowing costs aren’t good for companies that depend on domestic consumption, like the banks and the telecom. Higher rates are more mixed. A bank with strong deposits can benefit, because it doesn’t have to pay up for its transaction deposits, and Bank Central Asia is strong there. The downside is weaker loan demand and more credit stress if rates stay high. These are real negatives, but in my view not big ones.
Then the budget and the central bank. Moody’s and Fitch both moved their Indonesia outlooks to negative this year. The new finance minister is a technocrat who says the budget has to stay credible- trimming here and there. The central bank governor’s surprise exit in July raised independence questions, so I want to see that it holds. To me it’s a sign the government is listening to the market and trying to adapt, but the proof is still to come.
If that proof doesn’t come, I’d trim. At the company level, I’d trim if credit costs rise faster than loans grow, and I’d sell if governance problems show up in the banks themselves.
This interview was conducted with Bin Xiao, CFA, Portfolio Manager, in October 2026. Mr. Xiao joined Polaris Capital Management, LLC as an Analyst in August 2006, and was promoted to Assistant Portfolio Manager in 2012. He became an LLC member in 2013. In January 2021, Mr. Xiao was promoted to Portfolio Manager. He is a generalist and performs fundamental analysis of potential investment opportunities. Mr. Xiao works closely with his fellow portfolio managers in all aspects of portfolio investment and strategy.
SOURCES
Based on Bin’s comments, Polaris compliance added the following source materials as backup for the facts and figures in this interview.
Market data through October 20, 2026.
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