THE market is anxiously waiting to watch the results of the Morgan Stanley Capital International (MSCI) Semi-Annual Index review on Nov 13.

One of the reasons that the market fell by 615 points in the outgoing week, snapping a three-week gaining spree, was widely thought to be the investors’ fear over an unfavourable decision relating to stocks in the MSCI Emerging Market (EM).

From the five companies—Oil and Gas Development Company, Habib Bank Limited, Muslim Commercial Bank Limited, United Bank Limited and Lucky Cement Limited—that were included during Pakistan’s upgrade to the MSCI EM Index, effective June 01, 2017, most brokers, fund managers and analysts concur that a bank and another corporation are likely to be pushed back to the MSCI Small Cap Index as they fall short of the required EM criteria.

The possibility of at least two companies being eased out of the EM and relocated to the Small-Cap Index should be a major event. But neither regulators nor brokers have assumed a proactive role in trying to save the expulsions

To recall, the reclassification of the Pakistan Index from MSCI Frontier Markets (FM) to MSCI EM was widely believed to a significant event for the Pakistani market as it was thought to provide access to a larger pool of foreign funds tracking EM markets.

The exuberance caused by the expectations of foreign inflows of $400 million on the entry of the Pakistan Stock Exchange (PSX) into MSCI EM, had propelled the KSE-100 index to an all-time high of 52,000 points in a prolonged rally.

But hopes turned to dust when on the D-day, instead of net inflows, the market saw a mass exodus. The misjudgement caused the market dearly as the Index turned red and has been sinking since that fateful day.

In that perspective, the possibility of at least two companies being eased out of the EM and relocated to the Small-Cap Index should be a major event. But there is deafening silence as neither the regulators nor brokers have shown much concern or assumed a proactive role in trying to save the expulsions.

The lack of reaction is quite a contrast to the painstaking efforts by the Pakistani market regulators, investment strategists and companies at several international investor conferences, in putting up a solid case before the foreign fund managers for their positive vote to Pakistan’s inclusion n MSCI EM last year.

Market watchers forward various reasons for the callous attitude of market participants and regulators, foremost being their focus on more pressing problems such as the pressure on the external account front, fast depleting reserves and the new government’s frantic efforts to secure financial assistance packages.

Some market participants watching the KSE-100 Index melt by over 20 per cent to close at 41,389 points last Friday from the peak of over 52,000 points in June 2017 say that the Pakistani market was better off in the Frontier Market.

“Pakistan had a wider exposure due to a larger canvas and penetration in the FM,” says Faisal Shaji, market strategist at Standard Capital Securities. He believes that the Pakistani market would have caught the interest of foreign investors with its higher weightage and size, matching those of smaller markets such as Sri Lanka, Vietnam, Myanmar and others, in the FM.

Director Research and Business Development at BMA Capital Management Muhammad Fawad Khan, disagrees. He reckons that the ouster from EM was not conducive to the market as “it was likely to hit investor sentiments and impact the government’s future divestment plans”.

In an Oct 10 note, Mr Khan notes: “Likely deletion of stocks may further result in near-term outflow by foreign investors. Secondly, we see a period of uncertainty with respect to Pakistan’s future status in either MSCI EM or FM which may negatively impact flows by foreign investors. The announcement by MSCI remains crucial in this regard.”

Pakistan’s weight in the MSCI EM is estimated at 0.07pc as of the last quarterly review, which is likely to further fall with the exclusion of two more stocks from the Index. Assuming total funds of $350m to $400m, tracking the MSCI EM, Mr Khan estimates $34m-48m investment in each of the five current MSCI EM constituents by index tracking funds.

Hamad Aslam, director research and business development at Elixir Securities states in his Oct 15 report that the potential removal of a bank and a corporation would reduce Pakistan’s weight in the Standard Index to 4bps (from 6bps on Oct 15) and lead to foreign selling by Passive Funds.

Since the Semi-Annual Review on Nov 13 will be effective from Dec 03, it is implied that any consequent asset allocation changes by Tracker Funds would be made at the close of Nov 30.

Mr Aslam observes that the recent turmoil in Pakistan Equities have opened up valuations (forward price-to-earnings ratio down to seven times) but liquidity is fast eroding amidst unabated foreign selling and higher returns offered by competing asset class.

Even without taking into account the potential downgrade, Pakistan’s weight in the EM Standard Index will already come down to 6bps; while incorporating the possible allocation change in the two companies’ status implies that Pakistan’s weight post Review will likely be a paltry 4bps.

Market participants admit that the continuous exodus of foreign investors is a cause for concern as it is a major reason for the ongoing market decline. In calendar year 2018-to-date, foreign investors have sold equity worth a staggering $416m.

But a plug in outflows is not in sight. According to one estimate, foreigners still hold Pakistani stocks of to the value of $5.1 billion, which works out to eight per cent of market capitalisation and 29pc of the free-float of the Pakistani market.

Published in Dawn, The Business and Finance Weekly, November 12th, 2018