Pakistan reclassified in MSCI Emerging Market

MSCI has announced to reclassify Pakistan in the MSCI Emerging Market Index in its Annual Classification Review, with a proforma weight of 0.19% (amongst the lowest in the EM group). Pakistan’s leading brokerage house, AKD Securities estimates gross passive inflows of US$500 million upon formal inclusion.

While benefits to derive are numerous, increased foreign visibility and participation particularly amid continuous foreign selling (CYTD net FIPI outflow of US$36.4 million) along with potential multiple re-rating (PSX-100 index traded at an average P/E multiple of 10.2x over 2006-08) are likely to be the most profound.

Despite rallying by 8% since May'16 in anticipation of a favorable decision, brokerage house believes the reclassification announcement is likely to make room for a further continuation of the recent bullish momentum with select stocks (included in the MSCI EM index) leading from the front. PSX-100 Index can statistically gain 15 to 20 percent surpassing 43,000 level over the next 12 months.

It is widely quoted that up to US$1.6 trillion is benchmarked to the MSCI EM Index (including both active and passive). A proforma weight of 0.19% should result in Pakistan attracting at least US$3 billion in both active and passive flows. Assuming passive investment constitutes 15 to 20 percent of overall funds benchmarked to the MSCI EM Index, roughly US$500 million in gross passive inflows into Pakistan can be expected upon formal inclusion.

While Pakistan is now set to compete with EM economies, brokerage house remains optimistic on Pakistan's attractiveness in the index backed by a promising macro environment. Favorable macro trends (decade low inflation and interest rates coupled with external stability) support Pakistan's economic growth trajectory. Major growth themes are 1) spurring industrial activity and consumer demand, 2) investment in infrastructural development and energy generation, likely boost GDP growth above 5 percent over the medium term. With positive implications for corporate profitability, strong consumer demand and development initiatives are now reflecting into a robust topline of Cements, Paints, Glass, Automobiles and Food Producers (excluding sugar).

Wary of continuous selling pressure, brokerage house sees Pakistan's reclassification into the MSCI EM index as a key confidence booster for the market. However, the latent risks exist in the form of: 1) political, both domestic and foreign policy related and 2) Brexit can cause turbulence due to heightened risk aversion of global investors.

Pakistan stock market driven by foreign investors

The bull run continued during the week ended 6th May 2016. The PSX‐100 Index crossed 36,000 mark, yet failed in sustaining this level and closed the week at 35,974 level, up 3.6%WoW, as investors calibrated portfolios in anticipation of Pakistan's inclusion in the Emerging markets club.

Additionally, the index heavy Oil & Gas sector was propelled by strength in global oil benchmarks. While setting aside the political uncertainty arising from revelations included in the Panama Papers, measures to be adopted in the upcoming FY17 budget remain a key consideration in setting investors’ expectations.

News moving the market included: 1) inflation increased to 4.17%YoY during April'16 from 3.94%YoY in March'16, mainly on the back of hike in food, fuel and rental indices, 2) PTA is set to hold auction for Next Generation Mobile Services (NGMS) spectrum (3G) on 11^th June’16 aimed at generating Rs42 billion revenues and 3) the Ministry of Finance has fiercely opposed allocation of gas from Mari field to EFERT, arguing that the fertilizer manufacturer has defaulted on payment of GIDC, whereas the Ministry of Petroleum & Natural Resources is seeking approval for allocating 60 mmcfd to Guddu power plant and 31mmcfd to EFERT.

After rejecting the terms of reference (TORs) put forward by opposition parties, Prime Minister Nawaz Sharif and his legal and political aides agreed to rope in opposition parties in negotiations to draw mutually acceptable terms for the proposed judicial commission to probe the Panama leaks.

Gainers at the bourse were: LUCK, MCB, NML, ICI and PTC, while scrips losing value were: AKBL, LOTCHEM, APL and HMB. Volumes dropped by one percent on week on week basis to 242.3 million shares, where volume leaders were: BOP, SNGP, PTC and TRG. Foreign participation took a healthy turn, with foreigners buying US$21.2 million worth equities during the week against net sell of US$12.4 million last week.

As result season comes to an unexciting close, investors look ahead to flashpoints, particularly upcoming MSCI's Annual Market Classification review (announcement scheduled on 14^th June’16) where Pakistan is hopeful for re‐entry into EM status. Anticipating this, investors are likely to shift interest to blue chip plays, likely to enter the EM index, namely LUCK, ENGRO, HBL and MCB. Furthermore, a rising CPI (April’16 at 4.2%YoY) has set the stage for reversal in the interest rate cycle, with expectations for a tightening to initiate from 4QCY16.

Due to the continuation of bullish momentum at the local bourse, benchmark PSX‐100 index offered return of 3.8%MoM in April'16 rising to 34,719 points, taking CYTD gains to a modest 5.8%. Rallying oil prices along with a strong corporate earnings season where selected sectors (Cements, Autos and Electricity) were seen on top. Average volume for the month hiking by a whopping 61.6% to 235 million shares against last 7-monthth average of 154 million shares. Despite a change for the good in volumes, foreign selling continued to be the itchy point with foreigners selling US$18.1 million worth equities taking CYTD net outflow to US$122 million. As regards sector specific performances, mimicking global oil price trends the Oil & Gas sector was seen taking charge, in what looked like ages, followed by Commercial Banks and Automobiles, while Cements and Fixed Line Telecommunication lagged behind.

Oil & Gas Regulatory Authority (OGRA) on Friday notified 38.3% or Rs76.5/mmbtu decrease in feedstock gas prices for fertilizer sector from Rs200/mmbtu to Rs123.41/mmbtu, in lieu of Rs70/bag agreed reduction in urea prices by fertilizer manufacturers. Following this recent development and significantly lower fertilizer offtake (demand growth revised down to 4.7 million tons from 5.2 million tons earlier) leading to poor 1QCY16 financial results.