Indonesia has spent decades establishing itself as one of the world’s most important emerging markets. Now the country — Southeast Asia’s largest economy, with a gross domestic product of about $1.5 trillion — risks losing that standing, potentially jeopardizing billions of dollars in foreign investment.

In January, index provider MSCI Inc. warned that it might downgrade Indonesia’s equity market from “emerging” to “frontier.”Those classifications help determine how global investors allocate trillions of dollars across markets, influencing how easily governments and companies can raise capital. The warning crystallized long-standing concerns over ownership concentration and market integrity in the country’s equities, triggering one of the worst selloffs in the nation’s stock market.

Now MSCI is considering an even more drastic step. In mid-October, it said a downgrade to frontier status may not adequately reflect the severity of the country’s market problems and that it is considering reclassifying Indonesia as a standalone market. That would remove the country from MSCI’s major global indexes altogether.

Such a move would put Indonesia alongside Argentina, Lebanon and Palestine as markets with such a designation, and make it the first standalone market in Asia. MSCI is expected to make a decision by mid-2027.

Global index providers such as MSCI and FTSE Russell group most of the world’s stock markets into three broad categories: developed, emerging and frontier. The classifications are based on the size, accessibility and development of a country’s financial markets.

Indonesia is currently designated as an emerging market, which signals a country is large and mature enough to attract global investors but still carries greater risks than developed markets. Under MSCI’s framework, China, India, South Korea, Taiwan, Thailand and Malaysia are among the Asian economies classified as emerging markets.

One rung lower is “frontier status”, which is designated for countries with smaller financial markets, less access to foreign investors and have greater restrictions on capital flows. Bangladesh, Sri Lanka, Vietnam and Pakistan are in this category. They continue to attract foreign capital, but they generally draw from a smaller pool of investors than emerging markets.

Standalone markets sit entirely outside those main classifications. Standalone status is reserved for markets that don’t meet MSCI’s criteria for inclusion in either its emerging- or frontier-market indexes because of factors such as accessibility, investability or market structure. Losing access to both emerging and frontier market indexes could further weaken demand for Indonesian stocks, especially among those who track the benchmarks, putting additional pressure on share prices and liquidity.

Indonesia has held emerging-market status since 1989, when MSCI launched its Emerging Markets Index. Its inclusion helped to cement Indonesia’s place in global investment portfolios as its economy and capital markets expanded.

A downgrade to frontier status alone would likely trigger a significant outflow of investment from Indonesian equities. Analysts at Goldman Sachs Group Inc. estimated that passive outflows alone could reach as much as $13 billion in an extreme scenario. That’s because many global funds allocate capital according to benchmark indexes, meaning some would be required to reduce or eliminate their exposure to Indonesian assets if the country were removed from emerging-market indexes. A move to standalone status, which would remove Indonesia from MSCI’s main global indexes altogether, would be “unambiguously worse,” according to Citigroup Inc. analysts.

Such a large-scale withdrawal of foreign investment could put pressure on the rupiah, raise borrowing costs and leave Indonesia more dependent on domestic savings and government-backed financing. The impact would likely be greatest on large, liquid stocks with heavy foreign ownership, particularly banks and other companies that feature prominently in benchmark indexes. A sustained loss of foreign capital could also weigh on bank lending, infrastructure spending and business investment, ultimately slowing economic growth and job creation.

MSCI first warned in January that it was reviewing Indonesia’s market classification after raising concerns about shareholder reporting rules that it said could obscure the true ownership of listed companies. The index provider cautioned that the rules could undermine market transparency and increase the risk of improper trading activity. It subsequently paused some planned index changes and said a downgrade remained possible if regulators failed to address the issues.

The concerns come against the backdrop of Indonesia’s low stock-market free float — the proportion of listed companies’ shares that are freely available for public trading. Many of the country’s listed companies are tightly controlled by founders, families or conglomerates, leaving only a small fraction of shares in public hands. That can reduce liquidity and exacerbate share-price swings, increasing the risk of price manipulation and making it harder for large institutional investors to enter and exit shareholdings safely.

Indonesian regulators unveiled a number of measures this year aimed at addressing MSCI’s original concerns. But MSCI says that “significant concerns remain around market dysfunction, including continued suspected coordinated trading behavior and lack of evidence of meaningful enforcement.”In April, the Indonesia Stock Exchange doubled the minimum free-float requirement for listed companies to 15% from 7.5%; some companies were given up to three years to comply. Regulators also began publishing more detailed monthly disclosures of shareholders owning more than 1% of a company’s stock and flagging companies whose ownership is concentrated among a small number of investors.

Authorities said they would also accelerate plans this year to diversify ownership of the stock exchange and to raise stock-investment limits for insurers and pension funds, while state investment fund Danantara said it would continue buying local stocks. At the end of September, the Financial Services Authority issued a regulation allowing the Finance Ministry, Bank Indonesia and Danantara to take stakes in the Indonesia Stock Exchange once it is opened to outside investors.

MSCI initially welcomed the various reforms but warned that their effectiveness would depend on their implementation. In June, it postponed its review of Indonesia’s equities to allow more time to assess whether the new transparency measures were working. FTSE Russell, meanwhile, reaffirmed Indonesia’s emerging-market status in early October, citing reforms undertaken by local authorities.

A move to standalone status would come at a difficult time for Indonesia’s economy and would amplify existing concerns about growth and public finances. Even before MSCI’s warning, investors had grown increasingly concerned about Indonesia’s growth outlook, fiscal pressures and the cost of President Prabowo Subianto’s ambitious social welfare agenda.

The government’s flagship programs — such as a 240 trillion rupiah ($13 billion) free school-lunch initiative, the rollout of tens of thousands of village cooperatives, and a plan to build some three million homes for low-income households — have fueled concerns about future government spending and the sustainability of Indonesia’s public finances. Those concerns have been compounded by the Iran war, which has driven up energy prices, adding pressure to an economy that is heavily dependent on imported oil.

Indonesia could now face greater economic pressure over the long term, even as its budget deficit remains below this year’s target of 2.8% of GDP and the central bank has vowed to support the rupiah.

Bank Danamon analysts warned in a note that large foreign outflows from Indonesian stocks could put further pressure on the rupiah and make it more expensive for the country to attract the foreign capital it needs to support the currency. Still, they expected that such a downgrade would have a relatively limited impact on the economy and bank lending.

“However, prolonged exclusion from global benchmarks could weaken new equity issuance, raise investment financing costs and gradually weigh on private investment,” the analysts added.