MSCI downgrades Pakistan to Frontier Markets

Decision to come into effect from December 1

KARACHI:

In line with the market expectations, the Morgan Stanley Capital International (MSCI) announced on Wednesday to notch down Pakistan Stock Exchange (PSX) among lesser advanced economies into Frontier Markets (FM) index with effect from December 1, 2021.

It was classified in MSCI's leading Emerging Markets (EM) index since May 2017 when the benchmark KSE-100 Index hit an all-time high of 53,000 points, but the country failed to sustain the level and the index never returned to that high level since then.

Apparently, the market has largely factored-in the announced decision as investors continued to sell stocks for a few days at PSX. Accordingly, the MSCI’s decision to downgrade Pakistan into Frontier Markets (FM) from Emerging Markets (EM) stands 'negative-to-neutral' for investors. They (foreign and local investors) may still, however, dump stocks in an immediate gesture to formally acknowledge the decision and cherry pick stocks later at lower prices.

The benchmark KSE index dropped 188.56 points (or 0.4%) and closed at a two-week low of 46,730 points on Tuesday.

Experts believe the MSCI’s latest decision on Pakistan is a blessing in disguise, as it has brought PSX back into the limelight with its weight of 1.9% in Frontier Markets compared to a weight of mere two basis points in Emerging Markets at present. "The comparatively higher weight in FM would highlight PSX in the eyes of global investors compared to its negligible size in EM," Arif Habib Limited Head of Research Tahir Abbas said.

Oil and Gas Development Company (OGDC), Lucky Cement, MCB Bank, Habib Bank Limited (HBL) are the four companies from PSX that qualified for FM. They would carry a cumulative weight of 1.9% in MSCI Frontier Market index as per their closing share price on August 31, 2021, Aba Ali Habib Securities Research Analyst Zubair Jatoi said in a short commentary.

The size of PSX might grow in FM as the domestic economy is on expansion mode for over a year now. It is expected to grow by 4.8% in the current fiscal year 2021-22 compared to 4% in FY21. It had contracted 0.5% in FY20.

"Last time, PSX carried a weight of over 9% in FM index (during 2008 to 2017)," Abbas recalled.

Barring Vietnam, Pakistan is having stronger economic fundamentals compared to peer economies like Kazakhstan, Kenya and Bangladesh in FM. The better fundamentals with expansion in the economy would help inflate the size of PSX in FM index, going forward, he said.

The MSCI’s decision would help re-attract foreign investors to the domestic bourse who have continued to exit from the market for a few years now. "A larger number (90-92%) of active global investors track FM index to take decisions on investment in the stock markets around the globe," he said.

The developments (growing economy and PSX reclassification in FM) should support listed companies to regain their share prices. Accordingly, "the benchmark KSE-100 index should recover to over 50,000 points level the by end of December 2021," Abbas said.

Earlier, it recovered to four-year high of close to 49,000 points in June 2021 from five-year low of around 27,000 points hit in March 2020 in the wake of the Covid-19 pandemic.

Earlier in June 2021, MSCI proposed to downgrade PSX into FM from EM considering share prices (market capitalisation) at PSX maintained downturn since 2017 and complete its consultation in this regard with market participants (including global investors) till August 31, 2021.

"This conclusion follows feedback received from market participants from its recent consultation on a market reclassification proposal for the MSCI Pakistan Index," MSCI said in a statement in early hours on Wednesday (according to Pakistan Standard Time).

"MSCI will reclassify the MSCI Pakistan Indexes from Emerging Markets to Frontier Markets in one step, coinciding with the November 2021 Semi-Annual Index Review (SAIR)."

It is scheduled to hold the SAIR on November 11, 2021 while the review decision would come into effect from December 1, 2021, according to another announcement of MSCI made on August 11, 2021.

"Based on a simulation using pro forma data as of August 31, 2021, this would lead to the inclusion of four securities in the MSCI Frontier Markets Index with an estimated index weight of 1.9%," it said.

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. More specifically, index continuity rules have been applied since the November 2018 Semi-Annual Index Review to maintain the required three constituents in the MSCI Pakistan Index, it said.

"Since the November 2019 SAIR, there have been no securities in the MSCI Pakistan equity universe that meet the Emerging Markets size and liquidity criteria within the MSCI market classification framework."

Starting with the November 2021 SAIR, the MSCI Pakistan Indexes will be rebalanced using size and liquidity requirements for smaller, average liquidity frontier markets as described in section 5.2 of the MSCI Global Investable Market Indexes Methodology, it said.