Indonesia Was Finding Its Feet. Then Came MSCI

It’s also a humiliation for President Prabowo Subianto, who has placed great store in significantly accelerating economic growth. The task, which was a stretch in benign conditions, becomes out 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 decline on Monday.

It will 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 are also susceptible. The central bank and finance ministry have their work cut out, and their first goal must be limiting the erosion of trust. Indonesia has strived since January to stave off a downgrade from MSCI. The announcement Friday morning in Asia that it's considering applying the standalone designation stunned because it was worse than expected.

Initially, the question was whether the country would be stripped of emerging-market status and saddled with a frontier-market label. Now, that looks like a good outcome. If carried out, relegating Indonesia to the standalone rank would 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.

Stopping the worst kind, and dealing with instability in the interim, must become the government’s No. 1 priority. It's a real pity because Indonesia has worked 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 at the peak of the 1998 meltdown, is a perennial challenge.

The index compiler wants robust efforts by regulators to clean up the market, take a tougher stand against manipulation, and bolster transparency and surveillance. This is an early test for Prabowo's lieutenants. Finance Minister Suahasil Nazara and the Bank Indonesia chief Destry Damayanti are 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 think that MSCI's view is regrettable — and discuss what the administration is 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 tape a Post-it note to his computer that says “Don't Do It.”

For the central bank, Wednesday’s interest rate decision takes on new 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. The press 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 on Indonesia, the New York-based company said it’s stepping up scrutiny of Turkey's markets and will consider a downgrade from EM to frontier 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. More From Bloomberg Opinion: This column reflects the personal views of the author and does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners. Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously, he was executive editor for economics at Bloomberg News. More stories like this are available on bloomberg.com/opinion