Indonesia’s moment of truth creates space for India-style rally

[SINGAPORE] A looming MSCI downgrade has plunged Indonesia’s stock market into a once-in-a-generation rout.

For investors and policy makers alike, it has also sharpened focus on a potential way out – one that mirrors India’s transformation from a structurally constrained market into one of the world’s strongest emerging-market performers.

Indonesia is now picking up the pieces after being warned it risks being cut to frontier-market status, a move that would push the country off the radar for many global investors. The core issues, chronically low free float and thin liquidity, have long weighed on the market’s appeal. Addressing them could set the stage for a sweeping re-rating, according to investors who point to India as a clear precedent.

“Just follow exactly what India did,” said John Foo, founder of South-east Asia-focused Valverde Investment Partners. “That market boomed.”

India, now favoured by emerging-market investors for its booming stocks, record public offerings and swelling ranks of retail traders, faced a similar challenge in 2010, when authorities moved to address unease over dominant controlling shareholders, limited stock availability and a market overly reliant on hot money.

The centrepiece of that effort was a mandate requiring listed companies to maintain a minimum public shareholding of 25 per cent. Firms below the threshold were compelled to raise free float by at least five percentage a year, while newly listed companies were given three years to comply. The rules were reinforced by measures to improve transparency and widen access for foreign investors.

Those steps laid the foundation for a historic revaluation. India went on to attract US$1.25 trillion of foreign inflows since 2010, build one of the world’s largest retail investor bases and cement its status as a core emerging-market allocation, an outcome that offers a potential blueprint for Indonesia as it confronts its own market credibility test.

“Over the medium to long term, stronger float and transparency rules tend to expand the investable universe, reduce the risk premium demanded by investors, and attract more durable capital,” said Djumala Sutedja, investment director at BNP Paribas Asset Management in Jakarta.

Indonesia has so far partially echoed that playbook, calling for a 15 per cent minimum free-float requirement, which it aims to implement by March. But the success will largely depend on the reaction of Indonesia’s corporate sector, much of it controlled by wealthy families, and the responses have so far been varied. At least one tycoon opted for buybacks, which can help shore up share prices but moves free float in the wrong direction.

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For India, a key piece of the puzzle was the so-called Offer for Sale mechanism, which allowed companies to dilute stakes through a controlled, transparent, exchange-based process. Between 2012 and 2016, the founders of 187 Indian companies sold shares worth one trillion rupees (S$14 billion) through such offerings, while foreign investors invested 3.76 trillion rupees in Indian equities over the same period.

In Indonesia, the reaction of local institutional investors suggests there may be demand for a similar setup. While they broadly support efforts to lift free float in Indonesia, the funds warned against moving too quickly.

“They should allow sufficient time for corporates to comply without creating a disorderly market,” said Jeffrosenberg Chen Lim, head of research at Maybank Sekuritas in Kuala Lumpur. A compressed timeline would risk unleashing a flood of share sales that overwhelms demand, he said.

For India, the push for a higher free float was accompanied by a broader overhaul. The government eased restrictions on foreign investments across large swaths of industries from defence to construction. Eventually, it allowed 100 per cent foreign ownership under the automatic route in areas including coal mining, contract manufacturing and insurance intermediaries.

In Indonesia, the reaction of local institutional investors suggests there may be demand for a similar setup. While they broadly support efforts to lift free float in Indonesia, the funds warned against moving too quickly.

“They should allow sufficient time for corporates to comply without creating a disorderly market,” said Jeffrosenberg Chen Lim, head of research at Maybank Sekuritas in Kuala Lumpur. A compressed timeline would risk unleashing a flood of share sales that overwhelms demand, he said.

For India, the push for a higher free float was accompanied by a broader overhaul. The government eased restrictions on foreign investments across large swaths of industries from defence to construction. Eventually, it allowed 100 per cent foreign ownership under the automatic route in areas including coal mining, contract manufacturing and insurance intermediaries.

The payoff was structural. India’s weight in the MSCI Emerging Markets Index rose from 8.3 per cent in August 2020 to about 18 per cent by the end of 2024, anchoring sustained foreign inflows. The transformation was not linear, MSCI deferred some ownership-limit changes in 2020 but the direction was unmistakable.

That’s also a warning for Indonesia that success may be elusive and there will be bumps along the way. The two countries are also starting from different positions. Even before the market overhaul, India had a global weight and growth story that’s unmatched by Indonesia, warned Clarence Li, senior portfolio analyst at T Rowe Price in Hong Kong.

“India’s current market position is the result of many years of reforms,” Li said. “The change did not happen overnight.”

For now, the sell-off in Indonesia appears less a verdict on corporate fundamentals than a stress test of policy credibility. Earnings resilience remains intact at many companies and some investors are already viewing the downturn as a potential entry point.

India’s experience offers Indonesia both a silver lining and a warning. Market credibility is built over years, not weeks. The real test will be whether Indonesia can execute reforms with the same patience, consistency and resolve that ultimately reshaped India’s markets.

“Indonesia is already moving along a similar and encouraging path” as India did, said Sutedja of BNP Paribas Asset Management. “From here, there is room to build further momentum.” BLOOMBERG