Pakistan loses emerging market status after MSCI's downgrade

Morgan Stanley Capital International (MSCI) on Wednesday downgraded Pakistan to a frontier market due to low liquidity in key scrips included in the emerging market index.

This is the second time the index provider downgraded Pakistan to a frontier market after awarding emerging market status in 2017. The country was part of the MSCI emerging market index from 1994 until 2008.

"The Pakistani equity market meets the requirements for market accessibility under the classification framework for emerging markets, however, it no longer meets the standards for size and liquidity," according to MSCI statement.

Pakistan will become part of the MSCI FM 100 Index from May 2022, the statement said. The decision was expected as Pakistan had started falling below the MSCI’s criteria in terms of size and liquidity after it was promoted to an emerging market in 2017.

"Overseas investors sold shares worth more than $1 billion since the upgrade to an emerging market in 2017 as the benchmark KSE-100 index was down to 12 per cent from its record high," according to a fund manager.

Low presence

Pakistan has a weight of 0.02 per cent in the MSCI Emerging Markets Index, according to data compiled by Bloomberg.

"Only three stocks - Lucky Cement Limited, MCB Bank Limutes and Habib Bank Limited are included in the MSCI Pakistan Index, but none of them has met the size or liquidity criteria since November 2019," MSCI said.

The MSCI EM Index has three constituents from Pakistan, whereas MSCI FM Index is simulated to have four constituents – with OGDC being the additional constituent, the MSCI statement stated.

Not a surprise move

"The MSCI EM Small Cap Index has 13 constituents from Pakistan, whereas the MSCI FM Small Cap Index is simulated to have 19 constituents – with INDU, BAHL, ABOT, NBP, SYS and PKGS being the additional constituents," it added.

Samiullah Tariq, head of research at Pakistan Kuwait Investment Company, said the MSCI move is not a surprise for the market.

"The decision is in line with the expectation due to lower market capitalisation as post inclusion in the emerging market index, Pakistan’s market capitalisation in dollars declined as the stock index went along with the currency depreciation," Tariq told Khaleej Times on Wednesday.

Beneficial for Pakistan

Market experts said the MSCI action will benefit Pakistan as it will have a bigger presence on the MSCI frontier markets index. However, an outflow of funds from the market is expected as foreign investors are likely to withdraw up to $150 million of their investment from the KSE-100 index.

"Based on Pakistan’s weight of 0.02 per cent and estimated global passive emerging market assets under management of $400-500 billion, we estimate investments of passive EM funds in Pakistan to the tune of $125-175 million, where around $75-100 million are likely invested in main EM stocks while $50-75 million are potentially parked in small-cap EM stocks," the statement said.

As per the MSCI simulation, Pakistan is likely to have a weight of 1.9 per cent in MSCI FM Index and 5.5 per cent in the MSCI FM 100 index (at the time of Pakistan’s upgrade to MSCI EM from FM in 2017, Pakistan’s weight in MSCI FM 100 index was around 8.5 per cent).

"It is difficult to gauge flows with respect to FM due to lack of data availability, however, we estimate potential investment from FM funds to the tune of $100-150 million, where $75-100 million maybe in the main constituents. It is worth mentioning that some of the active FM funds have been investing in Pakistan even though it's classified as an EM," the statement said.

According to a note by Topline Research, the potential inflows and outflows remain early estimates and may largely net off.

"We believe the reclassification to frontier market from the emerging market may turn out to be beneficial for Pakistan in terms of reduction in foreign selling. Foreigners have sold equities worth $730 million (net) since Dec 31, 2019, and have sold equities worth $159 million (net) this year already. We expect the selling pressure from foreign fund to persist till at least Nov-2021, and may wade off post the rebalancing," it added.

• Pakistan