After years of gains, waves of IPOs and a market cap that was pushing close to $1 trillion, the Indonesian stock market had a no good, very bad year in 2026. In January, global index provider MSCI announced it was considering downgrading Indonesia’s stock market from Emerging to Frontier status. MSCI raised concerns about high shareholder concentration and irregularities in closely held stocks.

Large institutional funds allocate their portfolios in part based on these designations so a downgrade would guarantee massive capital outflows from Indonesian equities. This caused a big sell-off in January that seemed to have stabilized by June, after wiping out hundreds of billions of dollars in value. The OJK, Indonesia’s financial services regulator, introduced stricter shareholder disclosure and free float requirements. In recent months the market was gaining again.

Then, in October, MSCI announced regulators were not doing enough and that a double downgrade was on the table, with Indonesia potentially sailing past Frontier and right into a category called Standalone. It would be unusual for a big and growing market like Indonesia to be hit with such a drastic downgrade. This is especially true when we look at Indonesian blue chip stocks, like the big banks and telecom companies, which have very healthy balance sheets and are dividend-generating machines.

For the last decade or two, Indonesia has been steadily building and deepening its domestic capital markets including the stock exchange. Between 2010 and 2026, the market cap of the IDX more than doubled with hundreds of new companies going public. For an economy the size of Indonesia’s, and at its current stage of economic development, this is an important development.

Deeper domestic capital markets create more options when it comes to raising money. Growth and investment become less dependent on a single source of capital, like FDI. This reduces exposure to external shocks like capital flight and allows local retail investors to participate in the rising stock market. It is generally a welcome and necessary development.

The flipside is that as the stock market gets larger, it poses a greater systemic risk and requires increasingly competent supervision and regulatory oversight. In the last few years there have been some questionable developments in Indonesian stocks. Newly listed firms backed by large local conglomerates saw extremely high valuations relative to their earnings.

These firms also tend to have high shareholder concentration, with limited public float. When Barito Renewables went public in 2023, it became the most valuable stock on the IDX with a market cap of around $65 billion and net earnings of just $154 million. The majority of Barito Renewables is held by Barito Pacific, a large local conglomerate, and related entities.

After MSCI issued its first warning in January, Barito Renewables and similar firms saw their massive stock valuations crater. Now regulators are imposing fines on some of these firms, but MSCI is signaling it wants more than half measures. How regulators meet this challenge will be absolutely critical in the months ahead. The credibility of the entire exchange is at stake.

This does raise another question, which is whether MSCI’s downgrade threat is proportional to the offense. A downgrade of this magnitude is a big deal with massive repercussions for retail and institutional investors. The sustained sell-off has already wiped out hundreds of billions of dollars in value, including for retail investors who had been encouraged to invest in stocks and participate in Indonesia’s growing capital markets.

There is real possibility of overreach by MSCI here, particularly if they do not provide clear and transparent information about what specific enforcement actions they would find sufficient. Other global index providers, like FTSE Russell, have indicated no plans to downgrade Indonesia.

MSCI is using a broad-brush approach to force tighter regulatory action. It is good that regulators are levying fines and getting tough on companies with valuations so out of touch with earnings, and ownership structures that limit real public participation. But in the process a huge amount of value has been wiped out and the stock prices of perfectly healthy companies are being dragged down. It threatens to turn back over a decade of mostly solid progress on capital market development in Indonesia.

I also think this needs to be placed within the broader context of Indonesia’s contemporary political economy. The current government is increasingly caught between unorthodox policy choices, and the power of markets to discipline those choices. A falling exchange rate, rising borrowing costs, and capital outflows are the market sending signals about government spending and borrowing and other policy choices.

Now, MSCI is sending a signal that markets want more transparency in the stock exchange, and for regulators to take a strong stand against obvious manipulation. The government needs to show that it is getting the message, and acting on it with genuine intent. MSCI has used a clumsy approach with lots of collateral damage to deliver this message. But the truth is regulators should have already been taking a hard look at these firms, well before MSCI forced them to do it.