Morgan Stanley Capital International (MSCI), in its upcoming announcement, is less likely to imminently downgrade Pakistan's status to Frontier Market (FM) under any of its given framework, analysts said. MSCI is going to announce its much-anticipated Semi-Annual Index Review on May 13, 2019 (price cut-off will be any one of the last 10 business days of April 2019), shortly after 11:00 pm.
"This will be an important event for Pakistan as the country is under scrutiny by market participants for a potential downgrade to MSCI Frontier Market (FM) Index whose current weight in MSCI Emerging Market (EM) is estimated at 0.03 percent, down by 7-8bps since inclusion in June 2017," an analyst at Topline Securities said. In the present scenario, none of Pakistan's existing 3 constituents (HBL, OGDC, MCB), in any of last 10 business days of April 2019, meet MSCI's standard Free Float market capitalization criteria of $741 million while only MCB and OGDC manage to meet Full market capitalization criteria of $1,482 million, he said.
However, MSCI's 'Buffer Rule' of 2/3rd of Free Float and Full Market Cap of $494 million and $988 million, respectively, will likely keep Pakistan's market in the EM-index for now. Even if any one of the 3 stocks (MSCI Pak Standard Index) fails to meet the buffer rule criteria, the probability of Pakistan getting a downgrade is low in the upcoming review, in our view.
This is because, MSCI may then impose index continuity rule, according to which, the largest securities by free float-adjusted market capitalization among the securities included in MSCI Pakistan's Market Investable Equity Universe (25 securities) will be added to the Standard Index in order to reach 3 constituents. This index continuity rule will be applied if any one of the existing 3 stocks fall below the 2/3rd requirement of free float and full market capitalization, we believe. However, in the worse case, there may still be a chance of Pakistan being added to the review list for a potential downgrade, if Pak stocks fall short of meeting the 2/3rd of liquidity requirement (The Annualized Traded Value Ratio of 15 percent is the standard) or the MSCI thinks the country's market accessibility factor has deteriorated as was the case with Egypt.
In any case, MSCI, in its upcoming announcement, is less likely to imminently downgrade Pakistan's status to FM under any of its given framework. "Our view is based on the analysis of several case studies of countries (Argentina, Jordan, Morocco, Egypt, Peru and Greece) which were at risk of being demoted in past."
This is because, the procedure to downgrade a country usually involves a public consultation, followed by an announcement and then the final exclusion occurs after one year of the date of the announcement.
In case of Peru, in October 2015 following a consultation with the investment community, MSCI decided to formally add Peru to the review list for potential reclassification to FM as part of its 2016 Annual Market Classification Review, on account of low market liquidity. However, in its 2016 annual review, MSCI did not downgrade the country as it was meeting the minimum benchmark criteria of EM index that time.
Similarly in 2013, due to an economic crisis prevailing in Egypt, MSCI warned the country of starting a consultation process to downgrade it to FM status. However, in 2014 annual review, MSCI said that it was no longer considering to launch a public consultation on a potential exclusion of the MSCI Egypt Index from the
MSCI EM-Index, following the substantial increase in Egyptian foreign currency reserves.
In June 2012, both Morocco (from EM to FM) and Greece (from developed to EM) were put under review for a possible downgrade. While Morocco came under scrutiny for failing to meet liquidity requirements for several years, Greece was put on review for failing to qualify on several criteria for market accessibility. In its June 2013 Annual Market Classification Review, after keeping under review list for one year, MSCI announced to downgrade both the countries while in its Nov 2013 Semi-Annual Index Review, Greece and Morocco became part of the MSCI EM-Index and FM-Index, respectively.
Based on above cases, the whole downgrade process may take 1.5-2 years so that market participants get ample time to adjust their portfolios. We, therefore, believe that Pakistan's imminent downgrade in the upcoming review under any of MSCI's classification framework is unlikely given the time period involved as discussed above. The worse that may happen for Pakistan in the upcoming review could be that MSCI add Pakistan to the review list to potentially downgrade it to FM. However the actual downgrade may or may not happen. If MSCI does downgrade Pakistan, it will be the only country to date to be downgraded to FM, then upgraded to EM and then again downgraded to FM.
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