MSCI review: Pakistan may rejoin emerging markets in 2016

Decision has the potential to dramatically change dynamics of the Pakistan equity market

KARACHI: MSCI, a leading provider of international investment decision support tools, said on Wednesday it may reclassify the MSCI Pakistan Index from ‘Frontier Markets’ to ‘Emerging Markets’ next year.

“We will add the MSCI Pakistan Index to the review list for its potential reclassification to Emerging Markets as part of the 2016 Annual Market Classification Review,” MSCI said.

Global institutional investors use different MSCI indices -- such as frontier, emerging, China and US markets – to create balanced portfolios aimed at generating maximum returns while keeping in view their overall risk appetite.

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The decision may appear to be a routine reclassification of economies by MSCI, but it has the potential to dramatically change dynamics of the Pakistan equity market: MSCI Emerging Market Index is tracked by global funds worth about $1.7 trillion, according to Bloomberg data.

“Not only the size of passive fund flows will increase, many large Emerging Markets funds may return to Pakistan,” says Topline Securities investment analyst Muhammad Tahir Saeed about the possibility of the elevation of the MSCI Pakistan Index to Emerging Markets next year.

In its brief commentary on the decision, MSCI said most accessibility criteria of the Pakistani equity market meet the MSCI Emerging Markets standards, except for some potential issues with the stability of the institutional framework.

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“The Pakistani equity market has grown significantly and its liquidity has greatly improved. As a result, concerns about the potential for failing to meet size and liquidity criteria should there be a negative market event have receded,” MSCI noted.

Pakistan was part of the MSCI Emerging Markets between 1994 and 2008. However, the temporary closure of the Karachi Stock Exchange in 2008 led MSCI to remove it from the Emerging Markets and classify it as a “standalone country index”. MSCI made Pakistan a part of the Frontier Markets Index in May 2009 and it has remained as such since then.

The indexer says the MSCI Pakistan Index may potentially see its number of constituents decrease in the event of its reclassification to the Emerging Markets status. The reason for the reduction in the number of constituents is the application of more stringent ‘investability’ requirements for the MSCI Emerging Markets Index.

Pakistan currently has as many as 16 companies in the MSCI Frontier Markets Index, namely Engro Corporation, Fatima Fertilizers, Fauji Fertilizers, Habib Bank, Hubco, Indus Motor, K-Electric, Lucky Cement, MCB Bank, National Bank, OGDC, Pakistan Oilfields, Pakistan Petroleum, PSO, PTCL and United Bank.

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Based on a simulation using current data, MSCI believes the number of constituents will decrease from 16 to only six in the case of the possible reclassification. The removal of 10 companies from the index will result in a drop of 32% in its market capitalisation.

Notwithstanding the immediate drop in the index market capitalisation, the possible reclassification is expected to attract greater foreign inflows to the Pakistani equity market. “Although Pakistan’s weight in the Emerging Markets will be small, (the size of) funds tracking Emerging Markets is many times higher than (that of) funds tracking the Frontier Markets,” Tahir said.