Return to emerging market status

What it is and what it means

It is a general observation that these markets have a capitalisation in excess of a billion dollars and the volatility in exchange rates is rather stable

Pakistan Stock Exchange has been the best performing market of Asia, without a doubt. Evidence is the consistent bull-run since the first quarter of 2012 and the manifold increase in market capitalisation, which had nose-dived after the infamous market crash of 2008. Then a part of the emerging markets, Pakistan was relegated to the status of a standalone market, leading to huge capital outflows. However, a review in May 2009 saw Pakistan being restored as a frontier market.

I personally feel that these terms need a bit more understanding so that as investors, we actually know what impact these statuses have on countries involved. I will briefly explain standalone, frontier and emerging markets and how each has had an impact on Pakistan.

Emerging Markets

Countries included in this category do not possess the economic strength of heavyweights such as Japan, Canada and Germany, etc, but are in the process of establishing a mature market with more depth for investors. The risk in these markets is relatively higher, but obviously the returns are high too. It is a general observation that these markets have a capitalisation in excess of a billion dollars and the volatility in exchange rates is rather stable.

Frontier Markets

These markets are a step down from the emerging markets with the risk element a bit elated. The stock markets are still evolving with inadequate regulation and are mainly targeted by investors who are looking for multiplied returns, but of course with much more at stake. Political instability, substandard financial reporting and high volatility in exchange rates are common features of these markets. Sometimes, the depreciation in currency is more than the capital return being offered and hence not much attractive for foreign investors.

Stand Alone Markets

As the name suggests, these markets are dealt independently, without any correlation with any other market or country. These markets are classified as the most risky, with a strict caution for investors. Countries classified as standalone are usually facing hyper-inflation eg Zimbabwe, or are in a state of war eg Palestine. Pakistan was classified as a standalone market for brief period from December 2008 till May 2009 primarily due to a market crash which led to the stock exchange being suspended.

Upgraded to EM from FM

In a recent review meeting of Morgan Stanley Capital International (MSCI), Pakistan Stock Exchange received recognition for its continuous evolution and regulatory reforms, earning a promotion to the emerging markets for the first time since 2008. Pakistan gained the status of an EM in the 90s and barring the eight year absence from the league, it had consistently served as a haven for equity investors. The MSCI has decided that Pakistan will regain its position in the league starting June 2017.

Qatar and UAE, after being upgraded to emerging markets in 2015, experienced an inflow of $400 million each within six months of announcement. Pakistan, even though with a low weightage, is likely to experience hefty inflows which could range from $100 million to $500 million

Salient features of inclusion in the EM:

While the FM index had incorporated stocks of 36 Pakistan companies, the EM will cut this number down to 27 of which three will be large capital companies, six will be mid cap companies and 19 small cap stocks.

Pakistan’s potential large capitalisation companies that would likely be part of the list 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 Fertiliser 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 Fertiliser, Kot Addu Power Company, Fauji Cement, Dawood Hercules Corp, Packages, Pakistan Oilfields, Fauji Fertiliser Bin Qasim, Searle Pakistan, Maple Leaf Cement, Bank Al-Falah, Pak Suzuki Motor Co, Kohat Cement, Nishat Mills, Ferozesons Laboratories, IGI Insurance, Pak Elektron, and Millat Tractors.

According to the MSCI document, Pakistan Petroleum Limited, K-Electric, PTCL and few other stocks, which are part of the FM Index, will not be included in the EM index.

Index weightage downsized:

Pakistan enjoyed a hefty 8pc weightage in the FM index but according to the MSCI briefing, its weightage in the EM index will be 0.19pc, only above Czech Republic in the list whose weightage is 0.18pc. India enjoys 9.03pc weightage in the EM and is ranked at the fourth spot with China leading the table with 25.41pc. Nevertheless, Pakistan has the potential for growth and is likely to prosper further, especially with CPEC on its way to completion and improved energy supplies to the industry.

Capital Inflows likely, don’t miss out!

Qatar and UAE, after being upgraded to emerging markets in 2015, experienced an inflow of $400 million each within six months of announcement. Pakistan, even though with a low weightage, is likely to experience hefty inflows which could range from $100 million to $500 million. The investors should accumulate the stocks included in the MSCI index with a long term perspective as these companies are likely to drive the market sentiment over the next few months.

CPEC and energy projects still important:

Nevertheless, timely completion of energy projects by this government will prove to be a game changer and is likely to instill new momentum in this bull-run, which seems to be losing breath. Just a reminder that the circular debt crisis has re-emerged and seems to be a daunting task now. The government will have to address this issue as seriously as it is addressing the CPEC.