Pakistan Market Faces FTSE Rebalancing Outflow Concerns

Staff Report:
Despite positive developments like falling interest rates and a new $7 billion IMF program, the Pakistan market remains range-bound at the 77-80k index level due to fears of FTSE rebalancing-related selling. The quantum and timing of this selling are critical.

On July 3, 2024, FTSE Russell announced the reclassification of Pakistan from Secondary Emerging to Frontier Market status, with changes effective after close of business on Friday, September 20, 2024 (i.e., Monday, September 23, 2024). Uncertainty persists over the expected quantum of selling by Vanguard, a fund that follows FTSE as a benchmark.

Pakistan Stock Market Up 0.47% Amid Policy Rate Cut

In an earlier report titled “FTSE Rebalancing-Related Outflow: Opportunity or Threat,” dated July 9, 2024, we highlighted Vanguard’s cumulative holdings of $150-160 million in Pakistan stocks, with $120 million held across three funds, representing 78% of total holdings. These funds primarily track emerging and developed markets, using passive, index replication, or sampling approaches, and may divest their Pakistan holdings.

Historical changes in FTSE show notable precedents. In March 2023, DG Khan Cement, Nishat Mills, and Searle Pakistan were removed from the small-cap index, while System (SYS) was added. Vanguard, which held substantial shares in these companies, divested fully by November 2023, months after the rebalancing took effect. A similar trend was seen in the September 2023 changes when MCB Bank was removed from the small-cap index and sold out by the effective date.

Based on our review, selling typically occurs over months, depending on market liquidity, with some exceptions like MCB, which was sold fully by the effective date. Market participants suggest that the current FTSE rebalancing-related selling will also be gradual. Vanguard has likely sold $15-20 million of its Pakistan stock holdings as of September 16, 2024, with more expected before and on the effective date of September 20, 2024. Total selling is expected to take a few months to complete.

Historical comparisons with Peru and Morocco, demoted to frontier markets in 2020 and 2015, respectively, indicate that Vanguard fully divested from these markets in the month of rebalancing. The pace of selling in Pakistan suggests a similar trajectory.