Indonesia: Cheap, but MSCI keeps the exit open; Maintain 2.0 Stars on ASEAN, favour SG and MY

Key Points

•        The JCI's -39% YTD decline reflects both a sharp de-rating and sustained earnings downgrades. We believe the main driver is MSCI's review of Indonesia's market status, which has turned foreign selling from a cyclical rotation into a structural one.

•        MSCI's concern now goes beyond the index to how the market functions. Until regulators show enforcement that changes trading behaviour, we see reclassification to Standalone as the more likely outcome by June 2027.

•        Active funds are still overweight Indonesia and have positions to unwind. Domestic institutions have the capacity to take over the stock, but only gradually, which should cushion the downside without driving a recovery.

•        At home, policy credibility is improving, but growth is increasingly state-led. Abroad, high oil prices and a weak rupiah are keeping the cost of capital elevated, which limits how far the valuation can recover.

•        Earnings downgrades have slowed but have yet to turn, leaving the 8x valuation on an earnings base that has not stabilised. We remain cautious on Indonesia and maintain our 2.0 Stars “Not Attractive” rating on ASEAN, favouring Singapore and Malaysia within the region.

Indonesia has been the weakest market in ASEAN this year. The JCI is down -39% YTD, while Thailand and Singapore are up 23% and 17% respectively. What makes the decline severe is that it has come from two directions at once. The market has de-rated, with the forward P/E compressing from 13x at the start of the year to 8x, while earnings estimates have been cut steadily through the year.

At 8x forward P/E, the market is trading at its cheapest level in at least a decade, and the key question now is whether the downside is already priced in. Despite the heavy YTD sell-off, we believe the main driver, MSCI's review of Indonesia's market status, has yet to run its course, domestic and external conditions continue to keep the cost of capital high, and earnings estimates have yet to stabilise. The impact on its bond market was apparent as well, with the 10-year government bond yield rising to 7.69%, up 164bp YTD. Hence, we remain cautious on the Indonesia market.

Figure 1: Indonesia is the worst-performing market in ASEAN this year.

Figure 2: YTD bond routs have pushed 10-year Indonesia government bond yields higher.

MSCI's concern has moved beyond the index

MSCI’s proposal on 15 October to reclassify Indonesia from Emerging Market to Standalone status triggered the latest round of selling. A decision is due by 30 June 2027. As a Standalone market, Indonesia would sit outside the benchmarks of both emerging and frontier market funds, forcing funds that track these indices to sell their Indonesian holdings. Frontier status also remains under consideration. We believe the proposal reflects a deeper concern over how Indonesia’s equity market operates, with implications for investor confidence beyond index inclusion.

Local authorities have responded on several fronts. Regulators have committed to more granular ownership disclosure, covering shareholders above 1% and their affiliations, and to raising the minimum free float to 15% over three years, while IDX will remove high-concentration stocks from the JCI calculation from 2 November. On enforcement, OJK has announced IDR2.1trn in penalties associated with alleged violations involving three listed companies. These measures address the right issues, yet MSCI had already acknowledged most of them when it proposed the move to Standalone. We see three reasons why they have not been enough:

1.      Firstly, most of the reforms are commitments that have yet to be implemented, and MSCI is looking for evidence of improvement rather than announcements.

2.      Secondly, the reforms focus on the index and the large caps, while MSCI's concern has broadened to how the wider market trades, including small and mid caps once the index freeze is lifted. Removing stocks from the JCI changes the benchmark, but the stocks continue to trade.

3.      Lastly, penalties punish past misconduct, while MSCI wants proof that surveillance can detect coordinated trading early and that behaviour is changing.

Until there is evidence of sustained improvement on these fronts, we expect foreign investors to remain on the sidelines through the consultation.

That said, MSCI has said the consultation is not a binary decision and has left room for an interim assessment. While credible progress could improve the outcome before the final decision, we believe the risk of reclassification to Standalone remains elevated, as stronger execution and sustained enforcement across the market will take time to demonstrate.

Table 1: MSCI timeline: what to watch until June 2027

Date	Event	What to watch
2 Nov 2026	High-concentration stocks excluded from the JCI calculation	Changes the index, with no mechanical impact on its level; does not by itself address the trading concerns MSCI has raised
Nov 2026	MSCI November index review	Index freeze continues, with no Indonesian additions to MSCI indices
Nov 2026 – Apr 2027	Window to demonstrate progress	Enforcement actions by OJK and IDX, a transparent method for identifying high-concentration stocks, free float compliance and trading activity in these stocks: the signals MSCI has asked to see
31 Dec 2026	Temporary 7% lower auto-rejection limit expires	Whether trading remains orderly once the tighter daily limit is lifted
Feb 2027	MSCI February quarterly review	Any relaxation of the freeze would be the first sign that MSCI is crediting the reforms
30 Apr 2027	Consultation feedback deadline	Feedback from investors, exchanges and regulators closes
By 30 Jun 2027	MSCI final decision	Emerging, Frontier or Standalone; implementation timing remains subject to consultation. A broader outflow stress scenario of about USD16bn includes substantial active selling.

Source: MSCI, IDX, iFAST compilations.

Active funds still have positions to unwind

Indonesia's weight in MSCI EM fell from 1.16% at end-2025 to 0.43% by September, reflecting changes in constituents, free float and relative market performance. Moving ahead, based on UBS estimates, a downgrade could trigger around USD16bn of outflows, of which USD13bn would come from active funds, and global and EM funds remain overweight Indonesia relative to its shrinking benchmark weight. As such, we believe foreign fund outflows are likely to persist ahead of the decision, as shrinking index weights and liquidity risk could continue weighing on fund flows.

The YTD foreign fund flows reinforce our view. Foreign investors have sold a net USD5.5bn of Indonesian equities YTD, the largest annual outflow in a decade, and the selling has continued even as the market rebounded from its 19 October low. As the large banks account for most of the remaining foreign holdings and offer the deepest liquidity, we expect them to continue bearing the brunt of the selling.

On the other hand, local institutions such as insurers and pension funds could step in to support domestic equities, but a pipeline of rights issues adds to the supply that domestic investors need to absorb. Hence, while domestic buying should cushion the downside, we expect it to be too slow to offset foreign selling and drive a sustained recovery during the consultation.

Figure 3: Indonesia's MSCI weight has collapsed, yet EM funds remain overweight.Source: MSCI, Datastream, Bloomberg, UBS. Data as of 2Q26.

Figure 4: 2026 is the largest foreign outflow from Indonesian equities in a decade.

Figure 5: Local insurers and pension funds have more than halved their equity allocation since 2017.

Source: OJK, UBS. Data as of August 2026.

Past downgrades suggest selling peaks around implementation

Among past MSCI downgrades, Pakistan offers the closest precedent for how valuations behave through a reclassification of this kind. In 2008, MSCI removed Pakistan from its Emerging Markets index after the exchange imposed a price floor that effectively shut the market, a case that, like Indonesia's, centred on how the market functioned. Its forward P/E fell -76% from 11.9x to 2.9x, with the trough coming a month after the removal took effect, when forced selling was at its heaviest. Yet the recovery was equally swift, with the P/E back at 8.6x within eight months once Pakistan joined the Frontier index and the selling had run its course. Notably, the process also worked in reverse, with Pakistan's P/E re-rating to about 11.5x ahead of its return to Emerging Markets in 2017.

We draw three implications for Indonesia.

1.      First, the heaviest selling pressure came around implementation, which suggests the overhang on Indonesia is likely to persist until the outcome is decided and the remaining foreign positions are cleared.

2.      Second, the depth of the fall depended on domestic conditions, as Pakistan's 2008 collapse was compounded by the global financial crisis, and its later downgrade to Frontier in 2021 by a balance-of-payments crisis. For Indonesia, this places the rupiah and the fiscal position at the centre of the downside risk.

3.      Third, valuations recovered quickly once the selling was complete and the market had found a new holder base. Hence, we see the clearing of foreign positions, with domestic institutions stepping in, as a more likely catalyst for a recovery than the MSCI decision itself.

It is also worth noting that, at 8.0x forward P/E, Indonesia still trades at a premium to current Standalone markets such as Argentina at 7.0x and Nigeria at 5.2x. While these markets differ in size and in the reasons for their classification, the comparison suggests that a full Standalone discount has yet to be priced in should the reclassification proceed.

Figure 6: Current forward P/E of countries that are categorised in MSCI standalone status.

Figure 7: Pakistan’s forward P/E. 

Domestic credibility is improving, but growth is narrowing

On the domestic front, the policy backdrop has turned more constructive. The appointment of a technocrat Finance Minister in September has reinforced the commitment to the 3% fiscal deficit ceiling, and the government has reversed several market-unfriendly proposals, including a royalty hike, an export levy and a windfall tax. We see this as a genuine improvement in policy credibility, which removes one of the key overhangs from earlier in the year.

That said, the quality of growth is becoming a concern. The government's agenda relies heavily on state-directed investment through Danantara and flagship programmes such as free school meals and village cooperatives. Meanwhile, household spending remains soft, with cuts to regional transfers weighing on spending outside the major cities.

Hence, while GDP growth is expected to hold around 5%, its composition points to an uneven earnings recovery. A broader recovery in household spending would provide stronger support for consumer volumes and credit demand. As such, the divergence between investment and consumption lending argues against extrapolating resilient GDP growth into broad-based earnings upgrades.

Figure 8: Investment loans are growing at more than four times the pace of consumption loans.

Source: Bank Indonesia, Maybank IBG Research, iFAST compilations. Data as of August 2026.

Oil and weaker external funding are keeping the cost of capital high

On the external front, weaker FDI has left Indonesia more reliant on portfolio capital to finance its current account deficit. Although inward FDI recovered to USD4.9bn in 2Q26 from USD3.8bn in 1Q26, it was still -12.7% lower y/y, leaving 1H26 inflows -7.0% below 1H25. After accounting for outward investment, net direct investment covered only around 22% of the USD12.5bn current account deficit in 2Q26. We believe this leaves the rupiah more vulnerable to portfolio outflows, particularly as foreign investors continue to reduce their exposure to Indonesian assets.

At the same time, elevated oil prices are adding pressure to both the external accounts and government finances. With Brent above USD110/bbl, Indonesia faces a higher oil import bill and greater spending on energy subsidies, leaving less room under the 3% fiscal deficit ceiling. Passing higher energy costs on to households would further weaken purchasing power, while absorbing them through subsidies would limit the funds available to support the economy elsewhere. As such, we believe the government has limited scope to support consumption without putting its newly rebuilt fiscal credibility at risk.

These pressures are increasingly evident in the currency and bond markets, with the rupiah weakening past 18,000 against the US dollar and the government bond yield curve shifting higher across most tenors over the past month, taking the 10-year yield above 7.4%. While foreign bond flows remain positive YTD as of 21 October, the recent selling has removed an important source of support for the rupiah. Bank Indonesia held its policy rate at 5.75% in October but raised its deposit facility rate to 5.00%, while scheduling cuts to the reserve requirement in November and December, which we see as an effort to defend the currency while preserving liquidity for bank lending. However, with inflation approaching the upper end of its target band, a further 25bp rate hike before year-end remains on the table should pressure on the rupiah persist, keeping financing conditions restrictive.

Figure 9: FDI.

Figure 10: Foreign investors are now selling government bonds as well as equities.

Earnings downgrades have slowed, but have yet to turn

On the broader level, at 8x forward earnings, the JCI offers an earnings yield of 12.5%, about 5.1ppt above the 7.4% 10-year government bond yield. While the spread appears compelling, we believe a sustained re-rating requires improved earnings visibility and more stable financing conditions. This is why the rupiah and the bond market remain the key signals to watch.

On the earnings side, the headline numbers look healthier than they are. Consensus expects earnings to grow 11% y/y in 2026 and 13% y/y in 2027, but this growth comes off a base that has been cut repeatedly. The 2027 earnings estimate for MSCI Indonesia has been lowered by about -18% since the start of the year, and 12-month forward EPS now sits about -20% below its peak, a downgrade cycle exceeded only during the Asian financial crisis, 2001, the global financial crisis and COVID. We believe these revisions reflect the aforementioned pressures, as higher oil prices, a weaker rupiah, tighter liquidity and balance-sheet adjustments at state-owned companies weigh on estimates

Encouragingly, the pace of downgrades has slowed, with the three-month forward EPS revision improving to about -4% from around -12% in June. However, revisions have yet to turn positive, and with oil prices elevated and the rupiah past 18,000, we continue to see more downside than upside risk to consensus, particularly as growth remains concentrated in resources, banks and telcos.

Figure 11: The 2027 earnings estimate has been cut steadily since mid-2025.

Source: Datastream, MSCI Indonesia, iFAST compilations. Data as of September 2026.

Figure 12: At 8x, the JCI trades near 2 standard deviations below its 10-year average.

Prefer ASEAN peers such as Singapore and Malaysia.

Our take on Indonesia is that the conditions for a sustained recovery are not yet in place. We expect the MSCI review to keep foreign selling elevated during the consultation, domestic buying to absorb supply only gradually, and external financing pressures to constrain a valuation recovery. The slower pace of earnings downgrades is encouraging, and a turn in revisions would be the first signal to revisit our stance.

Hence, we remain cautious on Indonesian equities. For investors seeking exposure to the region, we prefer Singapore and Malaysia, whose earnings drivers are less exposed to the pressures facing Indonesia.

Upside risks

1.      Earlier than expected MSCI reassessment

Should OJK and IDX demonstrate credible enforcement against concentrated-ownership trading within the consultation period, MSCI may lift the index freeze or reassess Indonesia's classification ahead of June 2027. This would ease active fund outflows and allow the valuation discount to narrow. That should support Rupiah and regain foreign fund flows.

2.      Stronger than expected domestic institutional inflows

Regulatory measures requiring insurers and pension funds to raise their equity allocation would accelerate the domestic absorption of foreign selling and support a quicker recovery in the market.