Despite odds, Pakistan may keep its position in MSCI EM index

VIASalman Siddiqui
SOURCEThe Express Tribune
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KARACHI: The policies going to be adopted by the Pakistan Tehreek-e-Insaf (PTI) government under the International Monetary Fund (IMF) programme will devastate the country’s economy.

However, some people voice hope that this will be a transitional phase towards good days, but for now high inflation, low industrial and agricultural output, unemployment and poor corporate earnings all are reflecting poorly on the Pakistan Stock Exchange (PSX).

The PSX’s benchmark KSE 100-share Index has dropped to a three-year low below 35,000 points. Stocks are available at critically cheap values but buyers are rarely present. Resultantly, the trade volumes shrank to a seven-year low of 39.3 million shares on Friday.


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Despite these odds, there is good news. There are high chances that Pakistan will manage to maintain its position in the Morgan Stanley Capital International’s (MSCI) Emerging Market (EM) index and will successfully avoid a downgrade to the MSCI Frontier Market (FM) index when a bi-annual review is conducted on Monday (May 13). This outcome has been anticipated by at least three research houses keeping in view the rules and regulations of the world-renowned indices provider.

In the worst case scenario, the MSCI may initiate consultations for possible downgrade of Pakistan to the FM index. The consultations, which are almost a year-long process, may not even end up with a downgrade. There is example of Peru for which the MSCI initiated consultations for possible downgrade, but kept the country in the EM index following improvement in its macroeconomic indicators and the bourse in 2015. Global investors, having over $1.5 trillion in hand, track the MSCI EM index for making crucial investment/divestment decisions in world stock markets.

Pakistan meets the minimum criterion of having at least three large-cap constituents – Oil and Gas Development Company (OGDC), Habib Bank Limited (HBL) and MCB Bank – in the MSCI EM to remain part of the index. There were six including United Bank Limited, Lucky Cement and Engro Corporation at the time of reclassification of Pakistan into the EM index from the FM index back in May 2017 after a gap of nine years.

However, continued sell-off at the PSX, particularly in the three excluded stocks, led to their removal from the index as their market capitalisation fell below the required levels. Among the three stocks currently in the EM index, MCB Bank may not maintain its position. “In case of exclusion of MCB Bank, we eye a possibility of Pakistan Petroleum Limited (PPL) replacing the stock in the standard index as part of the ‘index continuity’ process,” BMA Capital analyst Syeda Humaira Akhtar said in a report on the MSCI semi-annual review.

Market watch: KSE-100 extends losses over weak economic outlook

Arif Habib Limited Deputy Head of Research Tahir Abbas and Topline Securities’ analyst Nabeel Khursheed argued that HBL may be removed from the index. They said none of the existing three Pakistani constituents met the minimum criterion of $741 million in free float market capitalisation while only MCB Bank and OGDC met the criterion of minimum total market capitalisation of $1.482 billion.

Therefore, the ‘buffer rule’ and the ‘index continuity rule’ would help Pakistan in surviving in the MSCI EM index and avoid the risk of a downgrade, the three research houses said in separate comments.

Pakistan’s weight in the MSCI EM index has dropped to 0.03% in the aftermath of a continued drop in OGDC, HBL and MCB Bank share prices amid continued sell-off in the stocks at the PSX. Earlier, the weight was 0.14% at the time of reclassification in 2017.

“While index continuity may help Pakistan to avoid the risk of a downgrade in the near term, the improvement in liquidity in the capital market and economic stabilisation remain the key to sustaining the current status; (countries are usually allowed certain time period to remove non-compliance with both quantitative and qualitative requirements),” BMA Capital’s Akhtar said.

She believes the improvement in market liquidity and economic stabilisation may be achieved through stability in key economic indicators – currency movement, external account, policy rate, inflation, etc), political stability, smooth progress on IMF bailout, smooth progress on measures to avoid placement in the FATF blacklist, elimination of tax on dividends (currently 15%) and/or capital gains tax (CGT) and liquidity injection through government funds.

Arif Habib Limited’s Abbas said Pakistan’s equity market had recorded a decline of 9.84% or 4,015 points – with US dollar-based negative return of 11.9% – since the last MSCI quarterly review in February 2019. The negative performance of the local bourse is attributed to a lack of direction on the economic front, delay in finalisation of the IMF programme, major changes in the federal cabinet and the economic team.

During the period (February 1 to April 30, 2019), the bourse attracted a net inflow of $18 million mainly concentrated in cement and commercial banks having net inflow of $14 million each, he said. In case the downgrade consultation process is initiated, it “may take 1.5-2 years, giving market participants ample time to adjust their portfolios. We, therefore, believe that Pakistan’s imminent downgrade in the upcoming review under any of MSCI’s classification frameworks is unlikely given the time period involved,” Khursheed said.

“The worse that may happen in the upcoming review could be that the MSCI add Pakistan to the review list to potentially downgrade it. However, the actual downgrade may or may not happen. “If the MSCI does downgrade Pakistan, it will be the only country to date to be downgraded to the FM (in 2008), then upgraded to the EM (in 2017) and then again downgraded to the FM,” he said.

the writer is a staff correspondent

Published in The Express Tribune, May 13th, 2019.

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