Saudi Arabia, Argentina Upgraded By MSCI: What It Means

There was notable news for emerging markets after the close on Wednesday and in light of the space’s recent trials and tribulations, it’s probably worth documenting it briefly (or what’s counts as “briefly” in these pages).

As Bloomberg’s Sebastian Boyd wrote this afternoon, “there are a few factors that could extend” what, for now, is a one-day EM rally and one of those factors is “a favorable MSCI decision on Saudi Arabia and Argentina.”

Well, MSCI’s decision is in and it’s a thumbs up. MSCI will include Saudi Arabia in the EM index and Argentina will be reclassified to EM status.

Here’s the official announcement (key points bolded):

MSCI Inc., a leading provider of indexes and portfolio construction and risk management tools and services for global investors, announced today that beginning in June 2019, it will include the MSCI Saudi Arabia Index in the MSCI Emerging Markets Index, the MSCI ACWI Index, and other global and regional indexes as applicable. This decision follows the implementation in the Saudi Arabia equity market of a number of regulatory and operational enhancements which effectively increased the opening of the market to international institutional investors. The proposal for inclusion received the support of the vast majority of international institutional investors that participated in the consultation. MSCI will include the MSCI Saudi Arabia Index in the MSCI Emerging Markets Index, representing on a pro forma basis a weight of approximately 2.6% of the index with 32 securities, following a two‐step inclusion process. The first inclusion step will coincide with the May 2019 Semi‐Annual Index Review. The second step will take place as part of the August 2019 Quarterly Index Review.

Additionally, MSCI announced the reclassification of the MSCI Argentina Index from Frontier Markets to Emerging Markets status. This decision followed the broad acceptance of the reclassification proposal by market participants that took part in the consultation. In particular, international institutional investors expressed their confidence in the country’s ability to maintain current equity market accessibility conditions, which is a key factor in MSCI’s classification framework. However, in light of the most recent events impacting the country’s foreign exchange situation, MSCI also clarifies that it would review its reclassification decision were the Argentinian authorities to introduce any sort of market accessibility restrictions, such as capital or foreign exchange controls. The MSCI Argentina Index will be included in the MSCI Emerging Markets Index coinciding with the May 2019 Semi‐ Annual Index Review. MSCI will continue to restrict the inclusion in the index to only foreign listings of Argentinian companies, such as American Depositary Receipts, as the feedback from international institutional investors stated that higher liquidity across the domestic market is needed before considering a shift from offshore to onshore listings. MSCI will reevaluate this decision as liquidity conditions on the Buenos Aires Stock Exchange continue to improve.

Needless to say, everything that you’d expect to get a boost from this did, with the Global X MSCI Argentina ETF jumping some 6% after hours and the iShares MSCI Saudi Arabia ETF rising more than 2%. Additionally, myriad ADRs for Argentine companies are up sharply. Here’s a rundown from Bloomberg:

• Loma Negra +13%
• Banco Macro +10%
• BBVA Banco Frances +11%
• Grupo Financiero Galicia +9.5%
• YPF +8.1%
• Telecom Argentina +5.6%
• Pampa Energia +2.5%

So what does this mean?

Well, for Argentina, it’s obviously welcome news and comes on a day when the IMF approved the $50 million line of credit.

“Coupled with [the IMF deal] it could lead to capital inflows into the country which will go a long way to reduce pressure on the central bank which has been working to stabilize the currency as EM sentiment sours,” Schroders’ Jim Barrineau writes in a note, adding “that makes it less likely that foreign exchange reserves will be used for that purpose, which improves the near-term credit outlook for the country as a whole.”

BlackRock now calls Argentina “interesting”.

“Even considering [the] recent rise in volatility in the country’s assets,  Argentina  continues to show potential attractiveness for long term investments, especially in the energy and infrastructure sectors”, the asset manager’s Axel Christensen said in a statement.

While you could argue with the investment thesis in light of recent events, you certainly can’t argue with the “interesting” characterization.

For his part, Finance Minister Nicolas Dujovne declared that the MSCI decision will help Argentina access cheaper credit, which is clearly helpful about now.

As for Saudi Arabia, the MSCI news comes less than three months after the Kingdom won EM status from FTSE, so this is just another vote of confidence and helps validate MbS’s push to open the country to foreign investment.

“This is a reflection of the vision of 2030 towards building an advanced and open financial market for the world; its role as a leading financial market and a hub for regional and global investment across the Gulf, Middle East and North Africa,” Commerce and Investment Minister Majid Al-Qasabi said, before predicting “a great impact on stimulating companies and the private sector by increasing the volume of investment opportunities toward them, enhancing liquidity in the financial market and fair valuation of the shares of companies.”

As far as the actual numbers are concerned, here’s a handy table from Goldman:

And here’s the key excerpt from Goldman’s note that breaks down the expected inflows:

How much inflows could this translate into? MSCI: Based on our strategists’ estimate of US$385 bn of passive and US$1.3 tn of active funds tracking the MSCI EM Index, we estimate around US$10 bn of passive and US$34 bn of active (assuming market weight active positioning) of potential inflows into MSCI Saudi, equivalent to 17 and 56 days of ADVs, respectively. FTSE Russell: According to FTSE Russell, there are approximately US$200 bn of passive funds tracking FTSE EM indices. Based on our estimated 3.0% weight for FTSE Saudi, we calculate around US$6 bn of potential passive inflows, equivalent to c.9 days of aggregate ADVs.

If you had to say which of these decisions was already priced in, you’d probably have to go with the Saudi nod.

That means if you’re looking for outsized reactions, you’re more likely to find them in Argentina and, most notably, in the beleaguered peso which will take all the help it can get.