Foreign funds may withdraw $2-3 billion after MSCI tweak

MUMBAI: India’s weight in the MSCI Emerging Market Index is likely to fall at least by a percentage point in the next one year, causing an expected outflow of as much as $2-3 billion investment by passive funds.

Events that are going to affect India’s weight in the index include an increase in the representation of Chinese mainland shares, addition of Argentina and Saudi Arabia, a modification in the calculation methodology for foreign ownership limits and erosion in the market value of Indian stocks. The country could take steps to reduce the impact of some of these and it should do that immediately, said fund managers.

Global index provider MSCI on Thursday announced that it would quadruple the weightage of Chinese mainland shares in the MSCI benchmark in three steps. It will increase the inclusion factor of Chinese large-cap stocks to 20% from the current 5%, with increments of 5 percentage points each in May, August and November.


On completion of this, the weightage of Chinese mainland stocks in the MSCI Emerging Market Index will jump to 3.3% from roughly 0.7% at present. India’s weightage will come down by 32 basis points, or 0.32 percentage point, resulting in an investment outflow of nearly $1 billion, as funds that invest according to the weight of the index components adjust their holdings.

Currently, China overall has a 32.12% weightage in the MSCI Emerging Market Index, which will go up to 34.72% by November, while India’s weightage will reduce to 8.13% from 8.45%. Korea has a 13.69% weight, while Taiwan and Brazil have 11.16% and 7.62%, respectively.

“Increase in the weights of Chinese mainland shares by 260 bps will result in a fall of India’s weight by 32 bps with an outflow of nearly a $1 billion,” said Sanjiv Prasad, co-head of Kotak Institutional Equities. “However, a $1- billion outflow over a period of six months from May to November will not have much impact on the market,” he added.

Some of the stocks that will be hit because of the change in weight are L&T with an outflow of $135 million, ITC ($96 million), Tata Motors ($78 million), and Mahindra & Mahindra, Dr Reddy’s Laboratories and GAIL (about $60 million each).

MSCI also proposed changes to the calculation methodology for foreign ownership limits for Indian stocks. The result of this depends on consultation process and will be announced on March 29. If the changes are accepted, it will reduce India’s weight in MSCI Emerging Market Index by a further quarter percentage point.

“India should take corrective measures by increasing the FPI limits in various sectors and should negotiate with MSCI to include stocks like HDFC Bank, Kotak Bank, etc, if it wants FII flows,” said Nilesh Shah, chief executive of Kotak Mutual Fund. “The government can also consider restructuring their holding of PSUs by transferring it to a trust, like what China did to increase their weights in the MSCI.”

MSCI had earlier announced that it would include Argentina and Saudi Arabia in the emerging market index, broadening the investor base in a move that could affect the representation of other countries, including India, in the benchmark.

Indian market capitalisation has declined by $90 million since the beginning of the year, compared with an increase in China, Korea and Brazil by $1.3 billion, $92 million and $118 million, respectively.