Why Pakistan’s expected MSCI drop in FM index could be a positive development

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With an allocation of only 0.02 pc in the EM index, it was difficult for Pakistan to catch the attention of emerging market fund managers.

Morgan Stanley Capital International (MSCI) has launched a consultation to downgrade Pakistan from its Emerging Markets Index (EM) to a Frontier Market Classification (FM).

The consultation period will last until October and downgrading is likely in November 2021.

But it was planned.

This is because over the past two years the Pakistan Stock Exchange has failed to meet the liquidity and market capitalization requirements of an emerging market.

The news has had a polarizing effect on the market – while some view the decision with fear, others are happy with the outcome.

Further study of the MSCI EM Index reveals that it is unbalanced. The allocation for Pakistan amounts to 0.02% while nearly 80% of the index is allocated to China (39.59%), Taiwan (13.87%), Korea (13.04%) %), India (9.96%) and Brazil (4.97%).

The remaining 23 countries collectively represent 20.56 pc.

Obviously, it is unfair to compare Pakistan with countries like China and that is why the border market is a natural and more appropriate classification.

However, the total assets under management in frontier market funds has declined in recent years and is now less than $ 5 billion. So while Pakistan’s allocation in the MSCI Frontier Markets index has been proposed at 2.3%, the reclassification is expected to result in outflows of over $ 50 million.

When Pakistan was reclassified in the EM index in 2017, Chinese A shares were not included. But later, the inclusion of China crowded out most other markets.

In the short term, the results are generally positive, but it has been difficult for Pakistan to catch the attention of emerging market fund managers with an allocation of only 0.02 pc.

This was a rounding error and investors preferred to spend their time looking at larger markets. At least among the frontier markets, Pakistan will be hard to ignore.

In fact, it’s no surprise that most of the funds that have invested in Pakistan are already focused on frontier markets.

In the longer term, however, the demotion is tragic.

In the 1990s, Pakistan was the darling of emerging market investors. As recently as 2005, Merrill Lynch had selected Pakistan among the three most preferred markets in Asia.

The trading volume on the Karachi Stock Exchange was higher than that of most Asia-Pacific markets such as Malaysia, Indonesia and the Philippines.

A former chairman of the Securities and Exchange Commission of Pakistan (SECP) told me that in the 90s the Chinese used to ask him for advice on how they can learn from Pakistan.

The gap between market liquidity in India and Pakistan was not more than ten times (it is now more than a hundred). The scholarship in Turkey was not launched until 1986, and its founding team studied Karachi as a case study.

Looking at this past, the regression has been rapid.

Ironically, this fall was driven by ill-conceived regulatory initiatives during the decade 2008-2018, in part due to the policies of people who had little or no experience of global markets.

I remember in 2004 an argument was made in the newspapers that a Tobin tax should be introduced in order to reduce trading volumes. Think about it: we were debating policies to reduce, not increase, market liquidity.

Unfortunately, all of these policies have succeeded.

As a result, as the regulatory infrastructure developed, market volume shrank by 90%, the number of new IPOs dried up, and retail investors moved to markets where regulators did not exist, mainly l ‘immovable.

There is a direct negative correlation between the rise of the city of Bahria and the disappearance of capital markets.

But all is not lost. I am glad that there has been a marked change in regulatory attitude since 2019.

The results are also evident. Trading volumes have tripled, new company listings are at record levels and the number of IPOs in fiscal 2021 (eight) is the highest in a decade.

So while the popular myth is that the lack of activity in the capital markets is somehow related to a lack of trust in brokers, real data has proven this to be wrong. The only factor that has changed between 2005 and 2008 and now after 2019 is regulatory attitude.

I hope that the positive change will continue and that the forces that led to the fall of 2008-2018 will not return. Downgrading is the penalty for these times – a costly lesson for Pakistan.

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