MSCI’s 2019 market classification review has not put Pakistan on watch for a potential downgrade to Frontier Markets status, possibly due to the protection offered by applicable buffers. The review’s outcomes include (i) decision to upgrade Kuwait to Emerging Markets status (subject to pre-conditions), (ii) launch of a consultation to reclassify Iceland as a Frontier Market (from Standalone status presently), and (iii) launch of a consultation to downgrade Peru from Emerging Markets to Frontier Markets status, if Peru falls short of the required three constituents.
If Kuwait is upgraded, it will have a c 50bps weight (and 9 Standard Cap stocks) in the MSCI Emerging Market Index, implying little impact to the weights of the current EM countries, including Pakistan. The potential launch of a consultation on Peru is arguably more relevant for Pakistan given that both have only the minimum three constituents in the EM Standard Index. That said, we note that Peru has technical issues (e.g. one of its constituents is headquartered outside Peru), unlike Pakistan for which the concern is quantitative (i.e. the size of its constituents).
Pakistan was upgraded to Emerging Markets status in 2017, with six constituents being part of the Standard Index (OGDC, MCB, HBL, UBL, LUCK, ENGRO). Since then, UBL, LUCK and ENGRO have been downgraded to the Small Caps Index, with Pakistan’s weight in the EM Index dropping from 15bps to just 3bps. Of the remaining companies in the Standard Index, MCB and HBL are currently below the minimum market capitalization criteria, while all three of OGDC, MCB and HBL stand below the free float market capitalization criteria (see table below). Even after the application of buffers (2/3rd of minimum levels), MCB and HBL look vulnerable. If the stock prices of Pakistan’s EM constituents remain under pressure and/or the PKR continues to lose value against the US$, the possibility of Pakistan being put on watch for potential downgrade to Frontier Markets status still exists (in the June 2020 review).
Pakistan continues to have attractive valuations (2020f P/E: c 6x; about a 50% discount to the MSCI EM Index) and has also seen net foreign buying this year (2019td: +US$42mn vs. a net outflow of US$1.7bn across 2015-18). We retain our positive stance on the market, but flag that Pakistan’s small weight in the MSCI EM Index may continue to discourage large foreign inflows, at least until the macroeconomic backdrop becomes more supportive.