MSCI Review: Pakistan’s days as EM, numbered?

March 27, 2019 (MLN): Pakistan’s current position in the MSCI Emerging Market (EM) index has stirred a ripple of concern within the country’s equity market, as MSCI’s Semi-Annual Index Review approaches.

The fact that Pakistan is currently only 3bps of the EM Index entails fear that the country might be considered for a downgrade to the Frontier Market (FM) Index in MSCI’s meeting on May 13, 2019, in which the existing indices will be reviewed.

Moreover, MSCI has recently revised its minimum market capitalization limits for Emerging and Frontier Markets and Habib Bank Limited (HBL)’s market capitalization remains below the minimum market size criteria for EM.

This translates into HBL’s elimination from the MSCI EM Index which would lead to Pakistan being downgraded from EM index to MSCI FM index, because at least 3 companies from a country should meet the minimum market size criteria for that country to remain on the EM index.

The other two companies on the EM index are Oil and Gas Development Company (OGDC) and MCB.

Another reason for concern in this regard is that none of Pakistan’s names meet free float market cap requirements without the need for the index continuity buffer, a unique situation within MSCI EM.

In a research note published by EFG Hermes, its analysts have assigned a 50% probability that Pakistan will be put on review this June, and if put on review, they are 100% sure of a downgrade.

These analyst have drawn their forecast on the downgrade actions of Morocco in 2013 and Jordan in 2008. “Jordan had only one constituent that met size requirements when it was downgraded in 2008. Morocco easily met size requirements at the time of the downgrade. However, Maroc Telecom failed liquidity in the May 2012 review, forcing a liquidity adjustment factor (LIF) of 0.5 times at the time,” says the report.

In the event of a downgrade, the earliest Pakistan can be downgraded to Frontier is November 2020. According to EFG Hermes report, “A downgrade would lead to $200 million passive outflows. However, it should also lead to Pakistan having a larger weight in Frontier and frontier emerging.”

Mattias Martinsson, Founder and Chief Investment Officer at Tundra Fonder stated on a social media platform that it MSCI is likely to give the market a breather to crawl back above threshold.

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