Feb. 19 (Bloomberg) -- Argentina will be downgraded to “frontier” from “emerging market” status by MSCI Barra on the Latin American country’s restrictions on capital flows.

MSCI, whose stock indexes are tracked by investors with $3 trillion in funds, will reclassify Argentina to its frontier index at the end of May, the company said in an e-mailed statement distributed today. Only American depositary receipts will be eligible for inclusion, the statement said.

“Argentina has been on the back burner for quite a while,” said Roberto Lampl, who helps manage $12 billion in emerging- market assets at ING Investment Management in The Hague. “We’ve seen government policies that haven’t benefited minority investors and haven’t seen much that has improved traction for foreign direct investment.”

MSCI said in June it would consider demoting Argentina and Colombia unless they cut capital flow restrictions. Since 2005, Argentina has required that foreigners deposit 30 percent of their stock investments with the central bank for a year to limit speculative inflows.

‘Free Flow’

“It’s these aspects that are restraining the free flow of capital in and out of the country, which is one of the important requirements we have,” Remy Briand, global head of index research at MSCI Barra, said in a telephone interview today.

Argentina’s benchmark Merval Index has lost about half its value in the last year as the global financial crisis and President Cristina Fernandez de Kirchner’s seizure of $24 billion of private pension assets undermined investor confidence.

Argentina’s demotion comes after consulting investors and informing authorities of the capital control concerns, Briand said. Colombia last year removed restrictions and will retain its emerging-market status, he said.

Briand declined to comment on the demotion’s likely effect on investor flows, saying only that frontier status gives the country access to a different pool of investors.

The demotion may be “marginally negative” for investor flows because foreigners already had cut Argentine holdings because of the government’s interventionist policies, including last year’s seizure of pension assets, said John Ditierri at Emerging Markets Management LLC.

‘The Demotion’

“The demotion is post facto,” Ditierri, who helps manage $20 billion at the Arlington, Virginia-based firm, said in a telephone interview today. “The country’s in turmoil. Nobody wants to invest there anyway.”

Tenaris SA, which accounted for about 70 percent of the MSCI Argentina country index, switched to the MSCI Italian index in November as trading volume rose in Milan and fell in Buenos Aires. In the same month, Citigroup Inc. equity strategist Geoffrey Dennis cut his recommendation for Argentina to “zero” from “underweight.”

Tenaris and the depositary receipts of Brazil’s Petroleo Brasileiro SA account for half of the Merval index of 14 Argentina stocks. Listed stocks in Buenos Aires had dropped to 82 as of November from a record 669 four decades ago.

Argentina’s private pension funds held about a quarter of shares available for public trading in Argentina, data compiled by the companies show.

Argentina’s six-year-old economic expansion is slowing as the global recession curbs demand for the country’s commodity exports. South America’s second-biggest economy grew 4.9 percent in the fourth quarter, the weakest pace since 2002, when the economy contracted 3.4 percent in the aftermath of the government’s $95 billion bond default.

To contact the reporters on this story: James Attwood in Santiago at jattwood3@bloomberg.net

Last Updated: February 19, 2009 12:23 EST