MSCI to begin consultation on proposal to downgrade Pakistan

Karachi: Morgan Stanley Capital International Inc (MSCI), a leading provider of benchmark indices and risk management analytical products, said that it will begin consultation on a proposal for Pakistan's reclassification from Emerging Markets to Frontier Markets, as it announced the results of the MSCI 2021 Market Classification Review.

MSCI announced the launch of a consultation on a proposal for the potential downgrade of the MSCI Pakistan Index from Emerging Markets to Frontier Markets status in one step coinciding with the November 2021 Semi-Annual Index Review, read a statement.

MSCI review on May 12: Pakistan may come under scrutiny again

“Although the Pakistani equity market meets the requirements for Market Accessibility under the classification framework for Emerging Markets, it no longer meets the standards for Size and Liquidity,” said MSCI.

“More specifically, index continuity rules, as described in section 2.4 of the MSCI Global Investable Market Indexes Methodology, have been applied since the November 2018 Semi-Annual Index Review to artificially maintain the required three constituents in the MSCI Pakistan Index.

“Additionally, since the November 2019 Semi-Annual Index Review, there have been no securities in the MSCI Pakistan equity universe that meet Emerging Markets Size and Liquidity criteria within the MSCI Market Classification Framework,” it added.

MSCI to scrutinize Pakistan's status

MSCI has sought feedback from market participants on this reclassification proposal until August 31, 2021, and will announce the results of the consultation on or before September 7, 2021.

Last month, MSCI announced outcome of its semi-annual review where Pakistan weight was upgraded to 0.023 percent as compared to 0.016 percent previously. Additionally, Pakistan’s weight in the small cap index was revised to 0.379 percent.

Impact on market

The potential downgrade in classification could be beneficial for Pakistan, said Topline Securities.

“We believe the reclassification to Frontier Markets from Emerging Markets may turn out to be beneficial for Pakistan in terms of increasing visibility amongst foreign participants,” stated a report released shortly after MSCI's announcement.

The report estimated potential investment from passive FM funds to the tune of $150 to 200 million where $125 to 150 million are likely to be in the main constituents. It said despite Pakistan being classified as Emerging Market some of the active Frontier Market funds were still investing in the country.

The report added that foreigners have been key participants at the Pakistan Stock Exchange (PSX), but have shied away due to Pakistan's minimal weight in Emerging Markets Index. However, it warned that Frontier Markets have lagged behind the bigger markets in recent times as liquidity has dried up due to Covid-19 and consistent underperformance.

Meanwhile, Arif Habib Limited, in its report, stated that the simulated index for MSCI Pak FM would have a total 23 companies including 4 standard and 19 small cap as compared to current 16 companies in MSCI Pak EM (3 mid cap and 13 small cap).

The MSCI Pak FM standard cap will include LUCK (35.5% weight), MCB (23.1%), HBL (22.2%) and OGDC (19.1%). Whereas, The MSCI Pak FM would have weight of 2.3% in MSCI Frontier Market Index and 5.8% in the MSCI Frontier Market 100 Index.

The small cap of simulated MSCI Pak FM will include PPL, MARI, ENGRO, UBL, FFC, POL, PSO, HUBC, INDU, EFERT, TRG, BAHL, ABOT, NBP, SYS, MTL, SEARL, BAFL, PKGS.

The Arif Habib report said that Pakistan’s weight was around 9.2% when it exited the frontier markets space in November 2017, which has come down to 5.8% due to a decline in the country’s market capitalisation on the back of significant depreciation in the Pakistani Rupee.

"While the weight of other markets has displayed an improvement as their currencies did not lose as much ground against the US Dollar," added the report.

Pakistan was also downgraded from the EM to the FM Index in May 2009 (9.2% weight) whereby foreign inflows arrived at $306 million during Jun 2009 to Dec 2009, and $530 million in CY10.

“We also highlight that currently the size of funds tracking the MSCI FM space has compressed to $6.5-7.5 billion, while most of them are active funds."

It said that although the Frontier Market has shrunk in size since 2017, amid global redemptions in the wake of COVID-19, “we believe our weight will gradually go up as markets rebound and attract pre-corona foreign inflows.

"The weight of Bangladesh and Nigeria market is currently frozen.

“Lastly, 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 $25million respectively, while outflows from small cap scrips are expected at $12-15 million."

It added that most of the FM funds are active funds, saying that inflows from these funds would offset the outflows from EM funds. “We estimate a net inflow of $100 million,” it said.

“Moreover, barring Vietnam, the fundamentals of the KSE-100 index are relatively stronger than those of the peer markets (with a higher weight) with valuations at very enticing levels. Overall dynamics of the KSE-100 index are comparatively stronger than the peer markets with a higher weight such as Kazakhstan, Kenya, Bangladesh etc,” said the report.