Emerging market status - II

In its annual review meeting the Morgan Stanley Country Index (MSCI) Board revealed that "the MSCI Pakistan Index will be reclassified to emerging markets status, coinciding with the May 2017 semi-annual index review...PSX would be inducted in the Emerging Market Index in June 2017."
A quick recap of our history with respect to the EM index is in order: Pakistan, classified to an emerging market status in 1994, was downgraded and reclassified to Frontiers Market status due to the temporary closure of the Karachi Stock Market (for 110 days) in 2008. The Morgan Stanley website notes that "in 2009, Pakistan was included in MSCI's Frontier Markets Index and the firm warned that the market needed to function without any trading disruptions for some time before being considered for reclassification in its EM Index". It took MSCI board seven and a half years to decide to place us back in the emerging market index and it would be another year, in June 2017, before the country is placed in that index.
The MSCI website further notes that the number of Pakistan companies would be cut down to 27, compared to 36 stocks in the frontier market index and will include three large capital stocks, six mid-cap and 19 small-cap stocks. The free float adjusted market capitalisation would be 16 percent lower under emerging markets. The website further notes that Pakistan has an average weight of 8 percent in the frontier market, which is a strong index and Pakistan stocks will be having a potential weight of 0.19 percent only in the emerging market, second to the lowest 0.18 percent weight of Czech Republic. India is the fourth largest heavyweight in the EM with 9.03 percent.
The Pakistani companies that are likely to be part of the list, as per the MSCI website, include Oil and Gas Development Company Limited (OGDCL), Habib Bank Limited and MCB Bank Limited. Mid cap category would be formed by United Bank Limited, moved from large cap in FM to mid cap in the EM, Lucky Cement, Fauji Fertilizer Company Limited, Engro Corporation, Hubco and Pakistan State Oil. Stocks that would form small cap in EM list include National Bank of Pakistan, Indus Motor Company, Fatima Fertilizer, Kot Addu Power Company, Fauji Cement, Dawood Hercules Corp, Packages, Pakistan Oilfields, Fauji Fertilizer Bin Qasim, Searle Pakistan, Maple Leaf Cement, Bank Alfalah, Pak Suzuki Motor Co, Kohat Cement, Nishat Mills, Ferozesons Laboratories, IGI Insurance, Pak Elektron, and Millat Tractors.
And tellingly the website notes that Pakistan Petroleum Limited, K-Electric, PTCL and a few other stocks, which are part of the FM Index, will not be included in the EM index.
The Finance Minister claimed that by being part of the emerging market Pakistan will be able to attract direct foreign investment. Perhaps the Finance Minister, an accountant by training, has little idea about the difference between foreign portfolio investment (FPI) and foreign direct investment (FDI). While both can be sources of funds yet with FPI there is no active involvement in management and investment instruments are more easily traded, less permanent and securities are easy to sell because they are liquid. In contrast, there is a long term commitment for FDI as it involves management and ownership control, is not easy to sell off or pull out of and is usually undertaken by those who have the necessary expertise or in other words there are elements of technology transfer and intellectual capital transfer. The two therefore should not be confused. And in this context it is necessary to note that during the past three years FDI has been even less than during the five years of the PPP led coalition government - and this is in spite of the PML-N claim that it is an investor friendly party. Thus in June-July 2012-13 net FDI was 1456.5 million dollars while in July-June 2016 net FDI was 1983.6 million dollars, and this decline is in spite of the China Pakistan Economic Corridor which envisages 46 billion dollar Chinese investment in infrastructure projects in Pakistan.
Being on an International Monetary Fund (IMF) Programme sends a positive message to both prospective portfolio and direct investors as the perception in the market is that the country would be compelled to undertake politically challenging reforms. IMF's Extended Fund Facility (EFF) will end this September and the budget for 2016-17 envisages a marked reduction in programme (budget) support as well as project assistance - a fact that would make prospective investors carefully consider reengaging in the stock market in June 2017 notwithstanding the grant of the emerging market status by Morgan Stanley effective next year in June.
And secondly and equally disturbingly political uncertainty is again at its peak with the government's continued resistance to incorporate any of the opposition's recommended terms of reference (TORs) for the judicial commission to probe the Panama Papers. Pakistan People's Party, Pakistan Tehreek-e-Insaf and Pakistan Awami Tehreek have already warned that they may be compelled to agitate on the streets after Eid if the government team continues the impasse on the TORs. But irrespective of the outcome of this latest controversy the government would be in an election mode by June of next year with elections scheduled in less than a year hence expecting a significant rise in the inflow of FPI may be wishful thinking.
These two factors notably not being on a Fund programme and political uncertainty may lead one to conclude that being in the emerging markets index may not be a magnet for FPI or FDI from June 17 till after elections 2018.