The Morgan Stanley Composite Index (MSCI) announced its annual market classification review on Wednesday and upgraded the Pakistan market from MSCI Frontier Markets (FM) Index to MSCI Emerging Markets (EM) Index. This will be effective from May 2017.
After this announcement by the MSCI, the benchmark 100-share Index of Pakistan Stock Exchange (PSX) Wednesday gained 1042.13 points during the day’s trading, an increase of 2.3 per cent, and closed at 38559.88 points compared to the previous day’s closing of 37517.75 points.
The index recorded its biggest single-day gain since March 31, 2015. It has been one of Asia’s best performers this year.
Research firms estimate the MSCI upgrade will result in about $400 million in inflows into Pakistan’s stock market by passive tracker funds alone.
Pakistan remained in the MSCI EM Index during 1994-2007, but was removed in Dec 2008 due to introduction of a price floor. In May 2009, Pakistan was shifted from ‘standalone’ to FM Index. Due to change in local rules, the stock exchange cannot close the market even in times of crisis.
Pakistan met all the quantitative and qualitative criteria for upgradation to MSCI EM. In today’s Webinar, MSCI said that in terms of quantitative criteria, which are market size and liquidity, Pakistan showed significant improvement during the last few years. This helped in Pakistan’s market reclassification to EM.
The following nine companies are to be included in MSCI EM as per today’s Webinar: Oil & Gas Development (OGDC), Habib Bank (HBL), MCB Bank (MCB), United Bank (UBL), Lucky Cement (LUCK), Fauji Fertilizer (FFC), Engro Corporation (ENGRO), Hub-Power Co (HUBC) and Pakistan State Oil Co (PSO). The simulated MSCI Pakistan Investible Market Index (IMI) has 27 companies.
Pakistan has to sustain the overall economic recovery along with quality listings of large float companies, Topline brokerage house said.
Pakistan has a 9 per cent weight in MSCI FM Index and 9.7 per cent in MSCI FM Small Cap Index. As per MSCI Webinar today, Pakistan’s weight in MSCI EM will be 0.2 per cent. Pakistan will be amongst one of the smallest country in MSCI EM along with Egypt and Czech Republic, which are also 0.2 per cent.
In Asian FM, Pakistan was part of Sri Lanka, Bangladesh and Vietnam. Now in Asian EM, Pakistan will be part of 8 other countries like China, Korea, Taiwan, India and Malaysia etc.
Although Pakistan’s weight in EM is much smaller, funds tracking EM ($1.4-1.7 trillion) are much larger than funds tracking FM ($17-20 billion). The analyst suggests gross inflow of $600 million by EM passive funds. In today’s Webinar, MSCI was of the view that flows in Pakistan market due to EM upgrade will most likely increase.
According to the Topline research report, this market reclassification is expected to trigger rebound in Pakistan market from current forward PE of 8.7x vs MSCI EM PE of 12.3x. This is based on similar increases witnessed by Qatar and United Arab Emirates (UAE) markets, which were up around 40 per cent in 12 months following announcement of reclassification to EM. Consequently, Qatar and UAE Market’s PE improved from 10.8x and 10.2x to 17.1x and 15.2x respectively.
It is interesting to see that it took Qatar and UAE markets 5 years from the date of intention to be included in EM. The delay was because of implementation of the delivery vs. payment settlement mechanism and limits on foreign ownership in these markets. There were no such issues in Pakistan Market.
The analyst said even though Pakistan’s share is significantly lower in EM compared to FM, its improving macros and upside from China Pakistan Economic Corridor (CPEC) will prove to be a compelling story in EM universe. This should attract investors despite its relatively small size.
According to AKD research report Pakistan estimates gross passive inflows of $500 million upon formal inclusion. While benefits are numerous, increased foreign visibility and participation particularly amid continuous foreign selling (CYTD net FIPI outflow: $36.4 million) along with potential multiple re-rating (KSE-100 index traded at an average P/E multiple of 10.2x over 2006-08 while included in the EM space) are likely to be the most profound. Despite rallying by eight per cent since May 2016 in anticipation of a favorable decision, analysts believe the reclassification announcement will make room for further continuation of the recent bullish momentum with select stocks (included in the MSCI EM index) leading from the front. In this backdrop, the KSE100 Index can statistically gain 15 per cent/20 per cent (reaching a level of +43,000 points) in the next 12 months with an event probability of 10.14 per cent (the highest in our probability distribution).
The analysts remain optimistic on Pakistan’s attractiveness in the index backed by a promising macro environment. Favorable macro trends (decade low inflation & interest rates coupled with external stability) support Pakistan’s economic growth trajectory. Major growth themes are 1) spurring industrial activity and consumer demand, 2) investment in infrastructural development and energy generation where we see GDP growth crossing five per cent over the medium term. With positive implications for corporate profitability, strong consumer demand and development initiatives are now reflecting into robust top of the line of cements, paints, glass, automobiles and food producers (ex. sugar). Within this backdrop, potential rerating post classification in to the EM space remains a key possibility (discount to EM markets can narrow down swiftly where currently Pakistan trades at 35%/33% discount to MSCI EM/MSCI EM Asia Pacific-Ex Japan index).