Morgan Stanley Capital International’s (MSCI) is scheduled to announce its Semi-Annual Index Review on 13th May 2019. It is 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%, down by 7-8bps since inclusion in June 2017.
In the prevailing 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 US$741 million while only MCB and OGDC manage to meet Full market capitalization criteria of US$1,482 million.
However, MSCI’s ‘Buffer Rule’ of 2/3rd of Free Float and Full Market Capitalization of US$494 million and US$988 million, respectively, will likely keep Pakistan’s market in the EM index for the time being.
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.
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.
However, in the worse-case scenario, 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% 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. The 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.