MSCI signaled a possible shift that would move Indonesia out of the emerging market category directly into standalone status, bypassing any frontier designation. That surprise set off a rout in equities, spilled into bonds, and knocked the rupiah past 18,000 per dollar as capital pulled back.
Those losses hit as other headwinds gathered - a firmer dollar, higher Treasury yields, and more expensive oil - raising concerns that outflows could run longer. Goldman Sachs Group Inc. estimates a move to standalone could trigger roughly 5.6 billion dollars in passive equity outflows, with another 2.7 billion at risk if FTSE Russell follows suit. So far this year, foreign investors have pulled out in excess of 5 billion dollars from Indonesia's equity market.
The turbulence is testing Governor Destry Damayanti's preference for targeted steps - currency intervention and hedging incentives - instead of broad rate increases that can cool the wider economy. Several forecasters at Citigroup Inc., HSBC Holdings Plc, and Bloomberg Economics swung toward tighter policy after MSCI's warning.
As of late Tuesday afternoon, half of 38 economists surveyed anticipated a hike this week, mostly a quarter-point, with a couple calling for a bigger 50 basis point move. Since the most recent hike in June, the main policy rate has remained at 5.75%. United Overseas Bank Ltd. economist Enrico Tanuwidjaja said BI may need to raise rates amid the rupiah's swift slide tied to the MSCI proposal, and he did not rule out a "more aggressive" 50 basis point step.
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Analysts are focused on how BI will limit any spillover if the stock selloff starts to bite other Indonesian assets. PT Bank Danamon Indonesia economist Irman Faiz noted an equity-index downgrade would not, by itself, force bond selling, but a reset of Indonesia's risk could lift the yield investors demand on government debt.
DBS Bank Ltd.'s Radhika Rao said BI could lift yields on its short-term bills, known as SRBI, to support inflows, and it could step in to steady the bond market to temper a sharp rise in borrowing costs. CIMB Bhd. economists Joel Cheung, Lim Yee Ping and Michelle Chia argued a hike now would bolster credibility and projected another in November, while warning BI's room to intervene is narrowing as dollar reserves decline.
A softer currency tends to raise the price of imported goods, and food costs already pushed inflation to a three-month high in September. BI has moved fast in past bouts of rupiah stress - it raised rates by one percentage point earlier this year, which included a 50 basis point step in May - so a preemptive increase would not be out of character.
Stocks did bounce on Tuesday after officials pledged steps to avert a downgrade, but questions linger over whether they fully address MSCI's concerns about opaque shareholding and coordinated trading. Without credible reforms, UOB warned Indonesian assets could trade at a lasting premium to emerging market peers. As PT Bank Central Asia economists put it, "Markets are increasingly betting on BI reverting to the tried-and-true policy of offering higher yields to lure foreign investors back," adding, "The question, however, is whether BI will remain reactive in assessing the need for further rate hikes or become more anticipatory in adjusting its policy mix." BI announces its decision Wednesday at 2 p.m. in Jakarta - a key cue for whether rates, SRBI yields, or currency tools do the heavy lifting to stabilize flows and the rupiah.
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