Last spring, the conventional wisdom in global markets held that the Argentine economy would soon be re-integrated into the Emerging Markets Index of Morgan Stanley Capital International (MSCI). That consensus was thwarted in June, however, when MSCI made its annual reassessment of Argentina, South America’s second-largest economy. In a move that surprised many, MSCI declined to raise Argentina’s official status from that of “Frontier” market to an “Emerging” market.
Argentina’s return to MSCI Emerging Markets status would have had a beneficial effect on its stock market and economy, but the country will have to wait at least another year to receive that much-needed shot in the arm. MSCI indexes for equities, bonds and hedge funds come in three categories — Developed, Emerging and Frontier — and are used as a standard for portfolio managers tasked with making investment decisions.
So-called Frontier Markets — including Romania, Kazakhstan, Nigeria, Kenya, Bangladesh and Vietnam — are considered riskier than Emerging Markets because they carry additional political, economic and currency risks. The MSCI Emerging Markets Index currently measures equity-market performance in 24 countries: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, South Korea, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey, and the United Arab Emirates.
MSCI’s decision to keep Argentina in the Frontier category “is kind of a slap in the face” for the country, says Wharton management professor Mauro Guillen. It will hurt because “investment banks are influential and they move money. I don’t think this is good, and I wouldn’t have done it.”
According to Wharton lecturer Stephen Sammut, the MSCI Index has become “an important touch point for a lot of investment decisions.” Sammut says Argentina is an upper middle-class country that has had “an extraordinary history of over 200 years of economic turmoil” but has been “doing almost everything right” lately under the reformist administration of President Mauricio Macri. For Argentina, which is trying hard to return to the MSCI Emerging classification, the latest decision “has to be very frustrating.”
Guillen explains that when the concept of the Frontier market was first introduced 20-25 years ago, such a market “was supposed to be a country that was not a poor country, but for which the label of ‘emerging’ market was not appropriate because it was too small a market” — unlike such huge markets as China, India or Brazil. “That was the original definition of the term.” But over the last few years, the term Frontier “has been used as a category that is somewhere less than an ‘emerging’ market in terms of the quality of its reforms.”
“[MSCI’s decision] is kind of a slap in the face” for Argentina.–Mauro Guillen
Argentina is a unique case. When its leftist government defaulted in 2001, notes Guillen, Argentina “fell from the categories, and it became a country that was not even categorized.” That had major implications for investments; there wasn’t a set of rules that would enable people to invest in the country, or operate there. For some time, Argentina wasn’t even rated, so it essentially “did not exist in global financial markets.”
The consequences of that period still tarnish Argentina’s brand among many cautious foreign investors. “To be categorized as a Frontier market is an indicator of a lack of trust for international investors who do not know much about each particular market,” notes Jose Dapena, director of the finance department of the University of CEMA in Buenos Aires. Dapena stresses that international investment funds possess statutes and mandates that permit them to make investments with certain limitations. These funds use such indexes as the MSCI as reference points for placing investments.
Thus, the fact that the Argentine market has been in the Frontier category prevents many institutional investors from taking positions in Argentine assets, even when they think that the risk is low and the returns are attractive. “A re-categorization [to Emerging status] would have opened the door formally to allocate part of their portfolios to these investments, and generate a flow of capital toward the economy. Frontier markets move close to several billion dollars in investments, while Emerging ones move between $1.4 and $1.7 trillion,” Dapena estimates.
Guillen says that MSCI’s recent decision to keep Argentina within the Frontier category “is not helpful because the investment bank is forgetting” that MSCI and other institutions should “want to provide incentives for [President] Macri to do the kinds of reforms that investors like. Macri’s leftist opposition “thinks in a very different way” than the Macri government does about free-market economic policies, Guillen adds. “This move to label Argentina as a Frontier market undermines Macri’s position and gives steam to his opposition, however disorganized it may be, and I don’t think that’s good. If anything, we should try to give Macri more support so he can overcome the resistance to the reforms he wants to introduce, which, I think, are the way for Argentina to move forward.”
Hope on the Horizon?
In defense of its decision to block Argentina’s ascension to Emerging status, MSCI explained that it was based on continuing concerns that investors need to “consider that recent improvements [in Argentina’s economic policy] — including the elimination of capital controls and currency exchange restrictions — must remain stable for a longer period of time to be considered irreversible.” In making such an assertion, MSCI was referring to the Macri government’s removal in December 2015 of foreign exchange restrictions, whose implementation in 2009 by the populist government of President Cristina Fernandez de Kirchner was the original cause for Argentina’s downgrade to Frontier market status.
To soften the blow to Argentina’s pride, an MSCI spokesperson said that Argentina would continue to be on the list of countries that can join the Emerging index in 2018. International investment funds maintain statutes and mandates that allow them to make investments with certain limitations.
Dapena considers it important for Argentina to return to the category of Emerging nations. “When it comes to the perception of international risk, Argentina is on the same level as the other Latin American economies that are in the same index.”
“Savvy people who are looking for a foothold in Latin America may see [investment in Argentina] as a golden opportunity.”–Stephen Sammut
It should also be kept in mind that with the growth of passive investment management, a large number of index funds and exchange-traded funds (ETFs) around the world accurately replicate the MSCI. Therefore, if Argentina had joined the index of Emerging countries in June, many of them would have had to jump into the market and buy Argentine shares until they duplicated the weight that these shares have within the indicator.
One of the greatest beneficiaries of Argentina’s return to the Emerging category would have been the Argentine stock exchange, which, according to estimates from JPMorgan, could have attracted investments worth $1.37 billion dollars. Before the decision was made known, various moves were already being observed around the country. U.S.-based MFS Investment Manager and Henderson Global Investors, two of the world’s largest investment and hedge funds, had decided to expand their market share in Argentina, according to the Télam agency. At the same time, Chilean giants Moneda Asset Management and Larraín Vial, as well as the Brazilian bank BTG Pactual had requested permission to open brokerage houses in Argentina, according to the La Nación newspaper.
Santiago Barraza, professor of finance at the University of San Andrés, says that the official reclassification of Argentina as an Emerging Market at some point may directly affect the demand and liquidity of Argentine assets. “This is potentially important, given that increased demand and liquidity of these assets can raise prices, lower the costs of financing companies, and promote investment and activity,” he notes “Reclassification would send a significant positive signal from MSCI to the rest of the global market participants regarding their perception of the future of the Argentine market.”
The decision also would have positive effects on the real economy of the country, according to experts. For Dapena, “in the short term, the increase in share value benefits investors, while re-categorization can improve the sovereign cost of debt by reducing country risk and lowering it, thus impacting the entire economy.” In the medium and long term, Dapena believes that “the development of the capital market is always a positive aspect for the economy in terms of growth and job creation.” He stresses, as well, that “all the empirical evidence shows that having more open and deeper markets generates benefits for the society as a whole.”
“Argentina is regaining credibility,” says Manuel Romera, a professor at IE Business School. “It is experiencing [improved] rates of growth, unemployment, direct investment and, above all, a much greater degree of consideration by foreigners,” he says. He emphasizes that Argentina’s “entire agricultural sector, information system, including the tourist sector, are pulling the economy ahead strongly,” a process that, in his opinion, “causes the financial sector and Argentine banks to see these improvements reflected in its market valuation.” Finally, he is convinced that any news that the country is about to join into the MSCI index of emerging countries would be “a new impetus for the economy to grow at the rate of 4% that we all expect.”
“To be categorized as a Frontier market is an indicator of a lack of trust.”–Jose Dapena
An Ideal Time to Invest?
Despite all that, could this be a golden opportunity for private equity investors to plunge into Argentina? Sammut notes that one measure of Argentina’s recent progress is that the country is “on the short list for countries to graduate from Frontier to Emerging market status” and that “the investment community fully expects it to be reclassified as an Emerging Market in the near future.”
If Argentina’s growth figures for 2017 do not meet the consensus forecast of 4%, then that “may have very little to do” with the issue of whether Argentina returned to Emerging status this year, argues Sammut. “And if they perform as expected” — reaching the 4% GDP growth target — “that probably has very little to do with the classification issue as well,” he adds.
Instead, the widespread economic slowdown in Latin America may well have more significance than the issue of MSCI classification when it comes to determining inflows of foreign investment to Argentina. “At least in terms of private equity investing,” which is the sector in which Sammut focuses, “Latin America for 2016 and well into 2017 — and possibly for the foreseeable future — has not raised as much money from non-domestic sources of capital as in previous years. There has been a general economic slowdown, and what happens in one country affects every country” in the region. In addition, “global trends in commodity prices have not helped the region, either.”
Sammut adds, “If Argentina continues on the upswing — and I believe that it will — then this is actually an extremely good time to invest” in the country. That’s because the “opportunities are probably very significant and the competition for deals is lower than it will be in the future…. This is the calm before the storm. And savvy people who are looking for a foothold in Latin America may see this as a golden opportunity. Within a year or two, things will probably start really accelerating — and by that point, the opportunities will probably be fewer — and more expensive. So, for an astute investor who wants to get ahead of the curve, this could be a good time.”
Meanwhile, Guillen is optimistic that Argentina will be reclassified as an Emerging Market in 2018. “Macri is making all the right kinds of decisions.”
Image: Gobierno de la Ciudad Autónoma de Buenos Aires [CC BY 2.5 ar (http://creativecommons.org/licenses/by/2.5/ar/deed.en)], via Wikimedia Commons