MSCI keeps Korea and Indonesia in EM, with Korea's reform path continuing and Indonesia's downgrade risk deferred

Overview

This report comments on the results of MSCI's 2026 annual market classification review. MSCI announced the review after the US market close on June 23, and the outcome was in line with Goldman Sachs' expectations: Korea was not added to the DM upgrade watch list, and Indonesia did not immediately enter an FM downgrade consultation, with both remaining in MSCI EM. The report focuses on the conditions for advancing Korea's market-access reforms and its potential DM path, as well as the impact of Indonesia's free-float and index investability issues on fund flows.

Core views

The core view is that Korea's reform direction remains intact, but policy announcements alone are not enough to support inclusion on the DM watch list; reforms need to be fully implemented, sustained, and reflected in actual investor experience. Indonesia's downgrade risk has merely been postponed rather than eliminated, and the future still depends on real improvements in disclosure, free-float recognition, and investability. Goldman Sachs maintains Overweight on Korea and Underweight on Indonesia.

Analysis framework

The report uses an index-classification framework, an assessment of market-access barriers, passive fund-flow analysis, and analysis of active fund allocation changes. The Korea section focuses on DM entry thresholds such as KRW trading conditions, account systems, short selling, and settlement; the Indonesia section focuses on free-float disclosure, MSCI/FTSE adjustments, passive redemption pressure, active fund de-risking, and macro data.

Methodology notes

• Index Classification and Market AccessMSCI Annual Market Classification Review

  EM, DM, and FM classification pathways

  Based on MSCI's assessment of market access, investability, and actual investor experience, the report evaluates whether Korea is approaching the DM watch list and whether Indonesia faces the risk of being downgraded from EM to FM.

• Fund Flow AnalysisPassive Index-Tracking Fund Impact Estimation

  The impact of index reclassification and weight changes on passive funds

  The report estimates Korea's potential weight in MSCI DM if it enters DM, as well as the passive outflows from MSCI and FTSE that Indonesia could face if downgraded to FM.

• Fund Holdings AnalysisEM/AEJ Active Fund Allocation Monitoring

  Changes in active funds' overweight versus benchmark

  By observing changes in the overweight positions of EM and AEJ active funds in Indonesia, the report assesses whether active capital has already reduced risk exposure in advance.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Korean equities

  Core bullish asset

  Strengths

  Solid tech fundamentals and attractive valuations; if it enters DM in the future, it could access a larger global capital pool.

  Weaknesses

  It still does not meet MSCI DM watch-list requirements, and its high MSCI EM weight could trigger rebalancing selling pressure.

  Comparison

  FTSE has classified Korea as DM since 2009, but MSCI remains the more widely used global capital benchmark.

  Risks

  Insufficient KRW market liquidity, operational burdens from short selling and settlement, and near-term volatility amplified by leverage.

• Indonesian equities

  Core bearish asset

  Strengths

  It has temporarily avoided MSCI immediately launching an FM downgrade consultation, and part of the roadmap for disclosure and free-float reform has been announced.

  Weaknesses

  Improvements in free float and investability still need to be verified, and the risks of stock deletions and FIF cuts have not been eliminated.

  Comparison

  Compared with Korea's reform-and-upgrade path, Indonesia faces a defensive challenge of maintaining EM status and avoiding a downgrade.

  Risks

  Potential EM-to-FM downgrade, passive outflows, continued de-risking by active funds, and weakening macro demand.

• MSCI EM index-tracking funds

  A funding channel affected by index classification and weight changes

  Strengths

  Provides a clear framework for estimating mechanical fund flows.

  Weaknesses

  High-weight countries may be affected by concentration and rebalancing pressure, while low-weight markets are prone to fund withdrawals caused by deletions or downgrades.

  Comparison

  Korea's rising weight brings selling pressure, while Indonesia's falling weight and investability issues create further outflow risk.

  Risks

  Changes in index rules, consultation outcomes, and the execution pace of passive funds may amplify market volatility.

• KRW foreign exchange market

  A key market-access variable for Korea's DM upgrade

  Strengths

  The launch of 24-hour FX trading in July 2026 and an offshore KRW pilot in 2H 2026 are potential catalysts for improvement.

  Weaknesses

  Offshore KRW remains non-deliverable, and onshore FX liquidity during extended trading hours is insufficient.

  Comparison

  It needs to move gradually closer to developed-market currency trading conditions, including depth, continuous liquidity, and narrower bid-ask spreads.

  Risks

  If reforms are not adequately implemented or investor experience does not improve, Korea's MSCI DM upgrade path will continue to be constrained.

Key data

• Foreign outflows from KoreaUS$81bnYear-to-date net foreign outflows from Korean equities, partly reflecting mechanical rebalancing pressure after Korea's weight in MSCI EM increased.
• Korea MSCI EM weight24%The report states that Korea's strong USD-denominated performance has lifted its weight in MSCI EM to about 24%.
• Korea potential MSCI DM weightabout 3.4%If Korea is upgraded to DM, its weight would reset to about 3.4% in MSCI DM, corresponding to a larger global capital pool.
• Korea potential reclassification timelineJune 2027 watch list, earliest announcement in June 2028, earliest effective date in May 2029This assumes Korea is added to the DM watch list and undergoes at least one year of consultation.
• MSCI Indonesia performanceYTD -40% (USD-denominated)Reflects pressure from market performance and index uncertainty.
• Foreign outflows from Indonesiaabout US$4bnYear-to-date net foreign outflows from Indonesian equities.
• Indonesia MSCI EM weight0.4%Its current share in MSCI EM is already low.
• Passive outflows already occurredabout US$2.1bnAbout US$1.7bn from MSCI and about US$400mn from FTSE, resulting from index adjustments in May/June.
• Potential downgrade-related passive outflowsabout US$5bn from MSCI; another about US$3.5bn if FTSE followsThis is Goldman Sachs' estimate for a full EM-to-FM reclassification scenario.
• Indonesia active fund allocationabout 50bp OW down to about 25bp OWThe aggregate overweight of EM/AEJ funds in Indonesia fell from about 50bp in January to about 25bp in May.
• Bank Indonesia cumulative tightening100bpRate hikes from May to June helped stabilize the rupiah but may suppress domestic demand.
• Indonesia household credit growth6.1% YoYBelow the historical average of about 10%.

Impact & implications

For Korea, failing to enter the DM watch list in the short term limits the scope for immediate rerating, but the reform milestones are clear. If improvements in KRW liquidity, account systems, and market access are delivered, this could ease the structural outflows caused by Korea's high weight in MSCI EM and concentration limits over the medium to long term. For Indonesia, avoiding an immediate downgrade reduces short-term tail risk, but free-float and index adjustments may still continue to cause stock deletions, FIF cuts, and fund outflow pressure, while weakening macro demand also undermines risk-reward.

Risks

• If Korea's reforms remain only at the announcement stage and are not fully implemented, it may continue to fail to enter the MSCI DM watch list.
• Offshore KRW, liquidity during extended trading hours, omnibus accounts, in-kind transfers, exchange data restrictions, and the short-selling framework may continue to constrain Korea's market accessibility.
• Korean equities may face volatility risk in the near term from leverage amplifiers.
• If Indonesia makes insufficient progress before the November 2026 index review, MSCI may still consider actions including an FM downgrade consultation.
• Uncertainty around Indonesia's free float, FIF cuts, stock deletions, and index investability may continue to suppress fund allocation.
• Although Bank Indonesia's tightening stabilizes the rupiah, it may weigh on domestic demand, credit, and retail sales.

What to watch

• Actual liquidity, spreads, and execution quality after Korea launches 24-hour FX trading in July 2026.
• Whether Korea's offshore KRW pilot in 2H 2026 can improve the trading experience for global investors.
• Whether MSCI believes Korea's reforms have been sufficiently implemented, sustained, and reflected in investor experience.
• Whether Korea could enter the MSCI DM upgrade watch list in June 2027.
• Indonesia's actual progress before the November 2026 index review on disclosure, investor classification, concentrated ownership framework, and the roadmap for a 15% minimum free float.
• Whether MSCI and FTSE continue to cut Indonesia's FIF, delete constituents, or initiate downgrade-related reviews.
• Whether EM/AEJ active funds continue to reduce their overweight in Indonesia.
• Whether Indonesia's household credit, retail sales, and rupiah stability deteriorate further.