Indonesia Was Finding Its Feet. Then Came MSCI

(Bloomberg Opinion) — The latest blow to Indonesia, from MSCI Inc.’s warning it’s considering removingthe country from its global indexes, couldn’t have come at a worst time. Southeast Asia’s largest economy appeared to be finding its feet after a rocky few years. Now, it faces an exodus of international capital.

The prospect that its stock market is ejected fromkey industry gaugesunless there are improvements in market governanceis more than just a setback. It’s also ahumiliation for President Prabowo Subianto, who has placed great store in significantly accelerating economic growth. The task, which was a stretch in benign conditions, becomesout of reach in the absence of investor confidence.

The benchmark Jakarta Composite Index, the world’s worst performer this year, tumbled almost 12% on Friday after the index provider’s threat, and extended the declineon Monday. Itwill likely be subject to further losses and currency bears are seeing this as an opportunity to push the rupiah toward a record low. Sovereign bonds arealso susceptible.The central bank and finance ministry have their work cut out, and theirfirst goal must be limiting the erosion of trust.

Indonesia has strived sinceJanuary to stave off a downgrade from MSCI.The announcementFriday morning in Asia thatit’s considering applying the standalone designation stunnedbecause it was worse than expected. Initially, the question was whether the country would be stripped of emerging-marketstatus andsaddled with afrontier-market label. Now, that looks like a good outcome.

If carried out, relegating Indonesia to the standalone rankwould amount to the first double downgrade since Russia was cut after invading Ukraine. A decision will be made in June and, while MSCI is prepared to hear from Indonesian officials, Jakarta is clearly looking at some downgrade. Stoppingthe worst kind, and dealing with instability in the interim, must become the government’s No. 1priority.

It’s a real pity because Indonesia hasworked hard since the Asian Financial Crisis of the 1990s to get back in the good books of investors to attract capital. MSCI has zeroed in one of the nation’s persistent vulnerabilities: weak governance.Corruption in government, which reached epic proportions under the autocrat Suharto who was ousted atthe peak of the 1998 meltdown, is aperennial challenge.The index compilerwants robust efforts by regulators to clean up the market, take a tougher stand against manipulation, and bolster transparency and surveillance.

This isan early test for Prabowo’s lieutenants. Finance MinisterSuahasil Nazaraand the Bank Indonesia chief Destry Damayantiare respected but still learning the ropes. They can’t afford many mistakes. They should choose their words carefully and ensure that their comments don’t morph into invective.They can argue why they thinkthatMSCI’s view is regrettable —and discuss what the administrationis doing to meet the concerns.

Suahasil’s predecessor lasted just a year and never recovered from an early poor choice. Upset that a Citigroup Inc. economist published a bearish report on the budget projections, the minister responded by attacking his credentials.Suahasil should tapea Post-it note to his computer that says “Don’t Do It.”

For the central bank, Wednesday’s interest rate decision takes onnew importance. The consensus is for borrowing costs to be kept unchanged. From a narrow perspective, such a conclusion would be reasonable: Inflation is within Bank Indonesia’s target range and growth is holding up.

But this no longer an ordinary monetary-policy meeting. Thepress conference will be dominated by inquiries about the likely downgrade and what magnitude of capital flight would prompt an increase. Destry might as well lean in and hike by a quarter or a half point. It would show the country can make tough decisions and prioritize the stability of the currency. A larger move may risk conveying a sense of panic —the last thing needed. Doing nothing might look complacent.

The president should back his new team. Turkey, which has a nasty habit of burning through central bankers and has suffered for years from high inflation, is also in MSCI’s crosshairs. The same day it delivered the bad news onIndonesia, the New York-basedcompany said it’s stepping upscrutiny of Turkey’smarkets and will consider a downgrade from EM tofrontier or standalone status.

Both Prabowo and Turkish President Recep Tayyip Erdogan have cast themselves as strongmen who can elevate their countries, strategically and economically. But this isn’t a time for living dangerously, nor for pointless posturing. The world is watching.