Thank you MSCI...

Finally, KSE has a reason to smile! All thanks to MSCI – the prominent provider of global equity indices – for putting Pakistan on the watch list for a possible reclassification to Emerging Market Index as part of its 2016 annual review. Recall that Pakistan was once part of the MSCI Emerging Market Index but was subsequently pulled out in 2008 owing to the stock market crisis that led to the implementation of ‘floor rule’. However, later in 2009, the country was able to take a step forward by entering the MSCI Frontier Market Index.
While announcing its results of MSCI Global Standard Indices, it takes note of the constructive developments on the country’s stock exchange during the last 12-18 months including the launch of Pakistan Unified Corporate Action Reporting System (PUCARS), controlling the negotiated deal market in a bid to deter unauthorized movement of client services and the introduction of online compliant managements systems. Needless to say, the management of Karachi Stock Exchange deserves due credit in this regard for taking dynamic initiatives to reinforce the confidence of investors. And while Pakistan meets the accessibility criteria of MSCI Emerging Markets standards, the impending concerns related to the institutional framework instability have not gone unnoticed by the MSCI.
But on the other hand, Pakistan’s weight is likely to witness a massive dip. If the estimates of Taha Khan Javed, the Head of Research at Elixir Securities, are to be believed, the potential weight of Pakistan will be around 0.2 percent as opposed to the country’s current weight of around 9 percent in the MSCI Frontier Market Index that ranks it as the fifth largest country in the basket. “But MSCI Emerging Market Index is very huge and the funds following the emerging markets are greater by a whopping sixty times in value terms than the funds following frontier markets”, Javed said while speaking to BR Research.
Moreover, based on MSCI’s simulation, the number of constituents from Pakistan is also likely to see a drop from 16 to 6, thereby leading to a drastic decline in index market capitalization of around 32 percent.
Referring to a research note by Arif Habib released just recently, MSCI Pakistan Index has remained a star out performer, thus outpacing the MSCI Frontier Market Index by 2.3 times in terms of average annual returns for the period.
“It is true that Pakistan’s weight will be smaller but as countries move on to developing market index from emerging market index, Pakistan will eventually gain over time. Besides, it will also help in strengthening the visibility, liquidity and depth of Pakistani stocks”, said Tahir Saeed, Deputy Head of Research at Topline Securities in a conversation with BR Research.
He added that the lion’s share of funds following emerging market is held by active tracking funds, whereby passive tracking funds are not too many and the criteria of reduced number of funds will only be applied to passive index tracker funds. In other words, it will still be permissible for active index tracker funds to take exposure in a wide range of Pakistan equities. Besides, he opines that increased flows will open up the possibility of a potential re-rating of the market.
Nonetheless, analysts at Arif Habib Research seem to be thinking otherwise! According to them, “It would be like being a very small fish in a big pond”. And they have certainly raised a valid point. While mentioning that the MSCI Emerging Market Index consists of heavy-weight countries with better economical prospects, the report added that drawing inflows from foreign fund managers might prove to be a challenge for Pakistan.
Be that as it may, there is no denying that this up-gradation would eventually be beneficial for KSE and to that extent all the brokers and analysts appear to be on the same page. But to find out if Pakistan is actually able to enter the emerging market index, one has to wait until the MSCI announces its 2016 annual review!