Daily Times

Pakistan has been re-classified to ‘emerging markets’ category in the Morgan Stanley Capital International (MSCI). What does it mean and why is it noteworthy?

MSCI is a global index compiler. It is a tool for exposure to the international markets. For instance if a German investor wants to invest in Vietnam, MSCI will be the tool to make that happen. Investors have different risk and return preferences. Generally higher risk is accompanied by higher returns and vice versa. Indices like MSCI allow the investors to put collective risks and returns of different markets into perspective and make choices. There are three categories for classifications of MSCI on these parameters; World, Emerging Market, Frontier Market, (World being the strongest).

Pakistan was classified as an ‘emerging market’ in 1994 and it maintained its status until 2008 when the financial crunch hit the global markets. The regulators in Pakistan’s stock market adopted stringent measures in response to the crisis and froze the market for three to four months. That created more than one problem for investors. To begin with, it cut down the liquidity of investments which meant that investors could neither withdraw nor exchange their investments. Furthermore, it also harmed investors who had debt positions and other arrangements which necessitated the liberty to take out and liquidate investments at any given time. This move reduced the credibility of Pakistani market by a great deal and MSCI downgraded it to ‘frontier market’.

It is notable here that the downgrading did not happen because the market itself malfunctioned. Had the regulators adopted any alternative means to handle the crisis instead of freezing it, the relegation might have never happened. Now, eight years after the crunch, Pakistan has been restored to the classification of ‘emerging market’.

A research analyst Sanakhawan Hussain sheds more light to what this re-classification actually renders. He informed that in the ‘frontier market’ category, Pakistan’s weightage in the index was 8-8.5 per cent, which meant that if $100 were invested in MSCI, $8 of them would have gone to Pakistan’s share. In ‘emerging market’ category, this share will now become 0.18-0.20 per cent. “The catch here is that even though the weightage is much less, it is still a lot more lucrative. That is because the total global money movement through the frontier markets is $20-$22 billion while the money that circulates through emerging markets is nearly $1.5 trillion,” he explained.

Even though Pakistan’s Gross Domestic Product (GDP) per capita fall short of GDP per capita of countries like Bangladesh and Vietnam, Pakistan will now enjoy emerging market status in MSCI while Bangladesh and Vietnam continue to operate in frontier market. That can be attributed to the less-stringent rules and regulations in Pakistan, which makes it more liquid and more fluid for investors.

The immediate effect of this reclassification is expected to strengthen Pakistan Stock Exchange (PSX) which is already showing rise of more than 1,000 points. The implementation of this ‘emerging market;’ status will take place in May next year. The one year gap is given for stakeholders’ ease and as an adjustment period for investors to change, add or withdraw their investments. Until then the inflow of foreign investments is expected to reach $300-$450 million in the upcoming year. Such valuations are considered to be permanent and irreversible hence the increase in inflows of investment can be safely expected to continue. However, if we take examples of UAE or Qatar who were also upgraded to ‘emerging markets’ by MSCI in 2014, we saw that their markets experienced 40 per cent increase in inflow of investments in the adjustment period and then saw deterioration of about 10-12 per cent of that increase. Similar trends are likely for Pakistan’s market.

Accompanied with this up-gradation was the failure of China’s A shares to reach emerging markets. China is part of this category but its A shares could not make it to the category as yet. This seems to be good news for Pakistan as the renowned economist Muhammad Aslam says,“if these shares would have made it then the nearly 0.20 per cent weightage assigned to Pakistan could have been even lower”.

There is no doubt that this reclassification will spell progress for PSX and foreign investments in Pakistan, but it will be a long shot to consider this as any revolutionising tool for the overall economic conditions of Pakistan. We run a budget deficit and a massive trade deficit and even if we estimate the investment inflow to increase by $500 million, it would do little if any to improve the Balance of Payments or overall economic strength. The only sure effect of this up-gradation is that Pakistan is back to a bigger platform and will receive more exposure to many financial sources and investors. From being a big fish in a small pond, now it is a small fish in a big pond.