An inflow of up to $500 million of foreign investment is expected in Pakistan stock market after inclusion in MSCI Emerging Market Index. "We anticipate passive inflows of $300-500 million based on a likely 0.15 percent weight of Pakistan in the MSCI EM Index, estimated EM tracking funds of around $1.5 trillion and 20 percent of these tracking funds being passive," Syed Atif Zafar, an analyst at JS Global Capital said.

The much talked about re-inclusion of Pakistan into MSCI Emerging Markets is around the corner with MSCI set to announce the list of constituents on May 15, 2017 (early hours of May 16 in Pakistan), which will be effective from June 1, 2017.

The lead-up to the upgrade has been nothing short of exciting as the Pakistan Stock Exchange (PSX) has recorded highly impressive returns of 8 percent in year to date 2017, 46 percent in 2016 and 34 percent since the MSCI re-inclusion announcement on Jun 15, 2016. "The expectations are that there will be one large cap, five mid caps and twenty small caps stocks in the MSCI EM", Atif Zafar said. In the backdrop of MSCI EM re-inclusion, the most intriguing bit has been constant selling by foreign investors. These foreign investors have sold a net $222 million, $339 million and $525 million in YTD 2017, in 2016 and since the re-inclusion announcement, respectively. Their holdings have declined to around 8.8 percent of the total market capitalization (to $8 billion) from 9.9 percent (ie $7 billion) in June 2015.

"The foreign selling is largely down to booking of profits (largely by Frontier Market funds) as they are yet to value in the benefits of CPEC given some skepticism over the materialization of corridor-related projects/investments and likely Pak Rupee (PKR) depreciation ahead / during /post the General Elections in 2018", he said. "We expect the skepticism to change as material progress has been made on the CPEC front, which should help allay concerns of foreign investors going forward", he added. Whereas the realization of higher expected return is also likely to downplay PKR depreciation concerns as such potential returns are unlikely to be matched in other markets.

Atif Zafar believed valuations are still attractive with PSX trading at 2017 E P/E of 11x a discount of over 35 percent to EM peers. Note that back in 2008 when Pakistan was part of the MSCI EM Index, PSX used to comfortably trade at over 14x its earnings - peaking at 16.1x in April 2008. The discount to EM peers was as low as 11 percent.

It is also worth highlighting that Pakistan's growth outlook also appears much more favorable as compared to its counterparts as Pakistan GDP growth is expected clock in at over 5 percent vis-à-vis an average growth forecast of 3% for the remaining EM countries.

Copyright Business Recorder, 2017