Asia’s best-performing stock market this year could be in for an additional boost if MSCI includes Pakistan in its emerging-market index for the first time since 2008.
The index provider added frontier-market Pakistan to its list for possible reclassification last year, citing improvements in transparency and liquidity. EFG Hermes said last month an upgrade could lure around $475mn of inflows by mid-2017. Pakistan has a “70% chance” of being promoted, according to Tundra Fonder, a fund manager specialising in frontier markets. The country’s benchmark index rallied the most in five weeks before MSCI’s decision in New York.
“Pakistan is moving into acceptance: the nation has what it needs, a decently functional state and decent stability,” said Mattias Martinsson, the Stockholm-based chief investment officer at Tundra Fonder, which holds $200mn of Pakistani equities. There will be a short-term negative reaction, which isn’t likely to be prolonged, if the country isn’t added, he said.
Prime Minister Nawaz Sharif is seeking to boost economic growth to its fastest pace in more than a decade after achieving stability through an International Monetary Fund loan programme that averted an external payments crisis in 2013. The nation also plans to end an energy crisis in two years with the help of $46bn of planned Chinese investment. Even so, Pakistan may struggle to get much attention as an emerging market.
The Karachi Stock Exchange KSE 100 Index has gained 15% this year, making it the best performer in Asia. The gauge has climbed 4.2% this month, compared with a 0.4% fall in the MSCI Emerging Markets Index.
“We have a pretty fair chance,” said Farid Ahmed Khan, the Karachi-based chief executive officer at ABL Asset Management Co. “The quantitative criteria we have largely met. On the qualitative criteria based on certain subjective assessments, there is always a doubt. My gut says that we are pretty close.”
Pakistan was downgraded to frontier status in December 2008, four months after the Karachi Stock Exchange imposed a rule that caused near total paralysis of market activity for more than three months. The bourse set an index floor to stop a plunge that wiped out $36.9bn of market value in about four months after then military ruler Pervez Musharraf left office to avoid impeachment.
MSCI’s Frontier Markets Index currently features 16 Pakistani companies that make up about 9% of the gauge. Valuations on the nation’s stocks have fallen over the past year, which may spur a rally if the nation gets upgraded, said Tundra Fonder’s Martinsson.
The United Arab Emirates and Qatar - the last two countries to be promoted to emerging-market status by MSCI - saw their benchmark share gauges jump by at least a third in the 12 months following their addition in June 2013. “You are going from a big fish in a small pond to a small fish in a very big pond,” said Ali Naqvi, co-head of global markets in Asia-Pacific at Credit Suisse Group in Hong Kong. “If you are small fish in a big pond then actually your story has to be really good,” he said, adding that it’s unlikely to be a doomsday scenario if Pakistan doesn’t make it.
Frontier-market funds are likely to keep much of their exposure to Pakistan if it regains emerging-market status, EFG Hermes said in a report last month.
“Pakistan’s market has been doing so well as valuations are some of the lowest in the region,” said Arthur Kwong, the Hong Kong-based head of Asia-Pacific equities at BNP Paribas Investment Partners, which oversees about €552bn ($623bn). 
“Basically people are looking for alternatives, finding markets that are less correlated to the US interest-rate cycle and the China macro slowdown. Pakistan, no doubt, is one of the outstanding spots.”