Bank Indonesia Faces Rate Hike Pressure as MSCI Threatens Downgrade

Indonesia's central bank faces growing pressure to raise interest rates on Wednesday as a potential downgrade of the country's stock market by global index provider MSCI threatens investor confidence, weakens the rupiah and increases the risk of capital outflows. Economists have revised their forecasts following a sharp market selloff, with proposed rate increases ranging from 25 to 50 basis points.

Citibank now expects Bank Indonesia to raise its benchmark seven-day reverse repurchase rate by 50 basis points to 6.25%, reversing its previous forecast for no change. Capital Economics and Permata Bank anticipate a smaller 25-basis-point increase to 6%. The central bank has maintained its benchmark rate at 5.75% since June, following cumulative increases of 100 basis points since May.

MSCI warned on Friday that it was considering reclassifying Indonesia from an emerging market to a standalone market, a status change that could prompt funds tracking emerging-market indexes to sell Indonesian equities. The Jakarta Composite Index recorded its steepest two-day decline on record before recovering approximately 3% on Tuesday after authorities announced measures to improve market transparency and price discovery, including removing tightly held companies from the flagship index.

The rupiah weakened to 18,030 per dollar on Tuesday, approaching its record low recorded in June. The currency has lost approximately 8% against the dollar this year, adding to concerns about financial stability and investor confidence.

Jason Tuvey, deputy chief emerging markets economist at Capital Economics, warned that leaving interest rates unchanged could intensify pressure on the currency and unsettle investors.

"Not delivering a rate hike [on Wednesday] would run the risk of disappointing investors and fueling further downward pressure on the currency," Tuvey said.

Tuvey also said a decision to maintain rates could revive concerns that Bank Indonesia was yielding to political pressure.

Citibank economist Helmi Arman expects a rate increase to help prevent equity outflows from spreading into the bond market and triggering capital flight by domestic investors. He anticipates a one-time increase accompanied by additional support measures, potentially including government foreign-currency borrowing or another round of bilateral currency swaps with foreign central banks.

Inflation presents a mixed backdrop for the decision. According to the reported figures, headline inflation accelerated to 3.28% in September, its highest level in three months but still within Bank Indonesia's 1.5%-3.5% target range. Core inflation eased to 2.84% over the same period.

Bank Indonesia Governor Destry Damayanti has said foreign-exchange reserves reached $146.3 billion at the end of September, providing adequate resources to stabilize the rupiah.

Josua Pardede, chief economist at PT Bank Permata, estimated that foreign investors had recorded approximately $5 billion in net sales of Indonesian equities this year. He warned that further withdrawals could weaken the currency and prompt investors to sell government bonds.

"Market confidence can deteriorate much faster than economic fundamentals," Pardede said.

Pardede estimated that an MSCI downgrade could trigger $3 billion to $5 billion in passive investment outflows, while another $15 billion in actively managed foreign capital could face reassessment. He expects market adjustments to unfold in stages, beginning with precautionary selling through the first half of 2027 and potentially followed by index-related selling if MSCI confirms the reclassification by June.

Pardede said the immediate challenge extends beyond the potential loss of emerging-market classification to the possibility that concerns about market integrity could raise Indonesia's cost of capital over the long term.

He called for reliable free-float data, fuller disclosure of share ownership and transparent engagement with international institutional investors. Pardede said Bank Indonesia could provide liquidity and limit excessive volatility, but credible market-governance reforms would be necessary to address MSCI's underlying concerns.