By Sujata Rao
LONDON, June 21 Crisis-racked Greece has become the first country to face the threat of relegation to emerging market status from the elite league in MSCI's equity indices, although the index provider said on Thursday any such move is unlikely before 2014.
Analysts reckon moreover that any downgrade would happen only if Greece exits the euro, a scenario the country's new coalition government is keen to avoid.
MSCI, which has $7 trillion benchmarked against its indices globally, said on Wednesday that Greece was no longer in line with developed markets' size requirements. It also said Greek authorities had failed to address concerns over certain kinds of transactions.
"The Greek equity market has experienced sharp declines, which are of course associated with the situation in Greece, the economic situation. The market has shrunk quite significantly," Dimitris Melas, MSCI's executive director, told reporters.
MSCI criteria for classification include investor access, as well as market size and liquidity, and the country's overall wealth. While the currency is not a criteria, Greek per capita income of $25,000 is significantly above MSCI's cut-off for emerging markets.
Greece made the jump from emerging markets to developed in 2001. But plunging prices mean Greece currently makes up only a tiny 0.0193 percent of the MSCI global markets index . That's down 80 percent from 0.16 percent two years ago, investors note.
"I don't expect early action on this but clearly they wanted to have something in place so that if Greece leaves the euro, they can act quickly," Maarten-Jan Bakkum, investment strategist for ING's emerging market funds, said.
"It makes sense (to put it under review) but Greece must first leave the euro zone if it is to become an emerging market."
He said a Greek exit from the single currency along with debt and a sharp devaluation of the drachma would lead to a scenario similar to that experienced by Argentina after 2001 with per capita incomes and GDP plummeting.
This may in turn force the Greek authorities to levy stringent capital controls to prevent widespread capital flight.
It normally takes MSCI 12 months to complete a review and another 12 months to implement any reclassification, which means that would not occur before June 2014, Sebastien Lieblich, head of index management at MSCI told a conference call.
But if Greece were to introduce capital restrictions "MSCI may be forced to act more quickly," he said, adding that this could take just weeks.
MSCI stipulates countries belonging to the developed index must permit easy movement of capital in and out of the market.
Deutsche Bank head of emerging equity strategy John-Paul Smith also sees the MSCI move as precautionary, arguing a euro exit would be the catalyst to trigger a downgrade.
"Politically it will be difficult for any index providers to reclassify a market as EM if it is in the euro," he said.
He believes Greece would fit well into the emerging markets category because of the high level of political influence on the corporate sector and said a move back to emerging markets could even turn out to be a boon for Greek equities.
"The market may get followed and studied a bit more within the emerging universe. If Greece were to leave the euro and went back to having its own currency it could become a very interesting play," Smith said. "After a big devaluation asset valuations of companies which survive the turmoil would be very cheap."
Greek debt has been in no-man's land for the past two years, after its bonds were thrown out of flagship global bond indices following a downgrade of its sovereign credit ratings to "junk". But it is yet to be included in JP Morgan's emerging debt indices, used by 80 percent of EM bond investors.
Some say more reclassifications could happen if the euro crisis deepens and emerging economies continue to strengthen.
"In our view this is an anomaly given many emerging markets' fundamentals are already better than numerous developed counterparts," Simon Quijano-Evans, chief emerging markets economist at ING Bank in London.
"Look out for more such moves in the opposite direction."