Indonesia, one of the world’s 20 largest economies, is facing the prospect of being removed from MSCI’s emerging market indices, a designation that would effectively classify its equity market as uninvestable. The potential downgrade, scheduled for a decision by next June, highlights ongoing concerns about the archipelago’s shrinking and increasingly dysfunctional stock market.

Foreign investors have reportedly withdrawn nearly $5 billion from Indonesian assets this year amid persistent market weaknesses. The Jakarta Composite Index experienced further declines recently, including a drop of more than 10 percent following MSCI’s announcement, marking its largest fall since the Asian financial crisis in the late 1990s. That crisis previously exposed Indonesia’s vulnerabilities, including significant foreign currency debt and entrenched cronyism.

While the market’s structure faces significant challenges—such as limited liquidity and regulatory shortcomings that contribute to practices like insider trading—many of the companies within the index remain fundamentally sound. Analysts argue that these dysfunctions primarily stem from weaknesses in market oversight rather than the intrinsic quality of underlying stocks.

In comparison to other recently downgraded markets, Indonesia retains strengths. For instance, Greece, which is set to regain developed market status next year, had comparatively fewer banking institutions when it was moved to a lower classification in 2015. Indonesian banks, by contrast, dominate the MSCI Indonesia index, occupying the three largest slots and multiple positions further down the list.

Despite concerns related to government spending and intervention, Indonesia’s banks are considered attractive investments due to their growth trajectories and profitability. Consensus forecasts by Visible Alpha project return on equity for leading banks such as Bank Central Asia and Bank Mandiri at 18 to 20 percent this year, outperforming comparable global peers like HSBC. Elevated net interest margins contribute to their financial performance.

However, these banks also illustrate systemic market issues. Most listed lenders have free floats below 50 percent, with significant ownership concentrated in government hands or among a few wealthy individuals. The situation is even more acute in smaller banks and companies. For example, an investigation into Barito Renewables found that nearly 97 percent of its shares are held by entities connected to its controlling shareholder. Barito Renewables was among three companies fined recently for trading violations, prompting regulators to remove stocks with concentrated ownership from the primary index.

Beyond the immediate concerns about market structure and ownership concentration, the Indonesian government’s heavy-handed approach remains a significant risk factor for investors. Although addressing low free floats and concentrated shareholdings could improve market transparency, it will not fully resolve overarching governance and regulatory challenges. Nonetheless, maintaining Indonesia’s presence on major indices remains vital for keeping the country visible to international investors.