MSCI expected to dump Pakistan out of emerging market index

KARACHI: MSCI Inc, the world’s largest index provider, on Friday proposed reclassifying the MSCI Pakistan Index from emerging to frontier markets as Pakistani equity market had not met all necessary requirements.

The index compiler will begin consultation with market participants on 31 August and announce decision on 7 September.

It will most likely to include MSCI Pakistan index in the Emerging Market Index, analysts said.

They said at least three companies have to meet the EM size and liquidity criterion and actually market capitalisation in Pakistan has been on decline since 2017, consequently pulling the country’s weight in MSCI EM Index down to 0.02 percent from 0.14 percent when it was upgraded.

Since November 2018, the country was given a leeway to attract emerging market funds despite lower market cap than required. Analysts are not unanimous about the downgrade impact on foreign portfolio investment.

“We think that a potential downgrade to MSCI FM will be positive for the market in the long run. Pakistan fits well in the FM space, both in terms of size and stage of economic development,” Intermarket Securities said in a report.

Analyst Fahad Rauf at Ismail Iqbal Securities concurred Pakistan would have a higher weight in FM and could attract more inflows than currently in EM.

The MSCI Pak FM is expected to hold weight of 2.3 percent in MSCI FM Index and 5.8 percent in the MSCI FM 100 Index. The MSCI Pak FM standard cap will include LUCK with weight of 35.5 percent, MCB 23.1 percent, HBL 22.2 percent and OGDC 19.1 percent. The weight was 9.2 percent in the FM Index back in 2017.

“There is a high probability for the Pakistan market to be downgraded to the FM Index. Weight in the MSCI EM index is only 0.02 percent versus 0.14 percent at the time of upgrade, less than the acceptable tracking error for most active EM funds,” a brokerage house Intermarket Securities said in a report.

Analysts also surprised over a possibility of downgrading of Pakistan to the FM status effective from November unlike last time when it took two years for MSCI to implement the country’s EM status in May 2017.

Analysts also questioned over the usefulness of Pakistan’s upgrade because they said foreign investment outflows from large active funds have been on a higher side in the past couple of years.

“Frontier funds, on the other hand, have been investing in Pakistan as off-benchmark positions since 2017,” Intermarket Securities said and estimated net foreign portfolio outflow of $1.9 billion between 2016 and 2020.

Currently the size of funds tracking the MSCI FM space stands at $6 to 7 billion and most of them are active funds.

Pakistan can still retain its emerging market status if it matches the quantitative criteria by September and that is possible when “the banks in particular would have to nearly double their market capitalisation, which seems improbable… unless there is a significant rally in the 3 main MSCI EM stocks (LUCK, HBL and MCB),” said an equity analyst. The day the country is reclassified in November, at least $200 million would fly out and FM funds inflows are not expected to stack up against outflows, according to Intermarket Securities said.

“We estimate outflows from funds tracking the EM Index to arrive at $111 million, effective from the day of exit. Expected outflows from LUCK, HBL and MCB are $45 million, $29 million and $25 million, respectively, while outflows from small cap scrip are expected at $12-15 million,” Tahir Abbas, head of Research at Arif Habib Limited. “Most of the FM funds are active funds and we view that inflows from these funds would offset the outflows from EM funds. We estimate a net inflow of $100 million.”

“We estimate potential investment from passive FM funds to the tune of $150- 200 million where $125-150 million are likely in the main constituents,” Atif Zafar, chief economist at Topline Securities.