The secret of Peru’s financial soundness and Argentina and Ecuador’s envy

The political crisis that broke out in Peru after the imprisonment of former president Pedro Castillo on December 7, 2022, has generated multiple protests throughout the country, and the clashes have left more than 60 people dead.

The situation is far from easing, yet it does not seem to impact Peru’s financial asset valuations significantly nor appear to be bringing down the economy.

The country continues to have the fourth lowest country risk in Latin America (only surpassed by Chile, Uruguay, and Panama in that ranking), and some of its bonds are slightly better than at the beginning of the year.

Indeed, the Peruvian sol does not have its best performance: the local currency has a decline of more than 0.5% in 2023, while there are currencies in the region that are appreciating, such as the Chilean peso (6.7%), the Mexican peso (6.06%) or the Brazilian real (2.3%).

Regarding equities, the Lima Stock Exchange is only 0.7% below what it was on December 6, 2022, i.e., the day before the beginning of the crisis.

Even with these last two nuances, the strong political crisis’s impact seems limited compared to what happens in other countries in the region when faced with adverse political situations.

To cite two examples:

Argentina suffered the second largest stock market fall in the history of global capitalism on August 12, 2019, after the formula that carried former president Cristina Fernández de Kirchner as vice-presidential candidate won in a primary election.

Cristina’s good result caused private dollar deposits in the country’s banks to fall by half, collapsed bonds, and generated a sharp jump in the dollar.

Recently, the force led by Ecuadorian President Guillermo Lasso was defeated in sectional elections.

In a few days, Ecuador’s country risk jumped 600 basis points, so the Ecuadorian government displaced El Salvador in third place of that damned ranking, placing it behind Venezuela and Argentina among Latin American countries.

To get an idea of the magnitude of the Peruvian political crisis, five former democratic presidents have been sentenced to prison in the last thirty years.

Even so, the dollar in Peru costs S/3.85, only 10% more than it did at the end of 2002, that is, twenty years ago.

For comparison, in Argentina, the dollar began the century with a 1:1 exchange rate, and today it costs about $370 in the parallel market.

The US currency appreciated there by 36,900%.

On the other hand, despite its political instability, Peruvian bonds are rated investment grade by risk rating agencies, something that does not happen with the sovereign instruments of Brazil, the region’s superpower.

WHAT IS PERU’S SECRET?

“The macroeconomic foundations are rock-solid and have been able to respond to numerous crises, including the current one,” explained Peru’s former Minister of Economy and Finance, Carlos Oliva.

In addition, Oliva supported this statement in the following aspects:

“Part of the explanation lies in a political Constitution that includes elements that facilitate such macroeconomic soundness, such as the independence of the Central Reserve Bank and its prohibition to lend directly to the government, equal conditions for domestic and foreign investment, freedom to own other currencies, ban to affect contracts through laws and other articles included in the economic title of the 1993 Constitution″.

“One could also add the experience of the economic mismanagement of the 1980s, which left some lessons, such as how pernicious fiscal deficits are. Although this also happened in other countries that seem not to have learned that lesson, it is easier to be fiscally responsible when you have padlocks in the Constitution.”

For his part, the director of the Peruvian Institute of Economics and the Central Reserve Bank of Peru, Diego Macera, summarized: “Despite all the political scandals, Peru’s macro indicators are still solid”.

From this summary, Macera detailed the reason for his statement in the following points:

“The first thing is that the accumulated fiscal strengths are still there. We have half the gross debt as a percentage of GDP than the region’s average; inflation higher than we would like, but also at almost half the regional average during 2022 (and without raising the reference rate too much); investment grade; extremely balanced fiscal accounts; international reserves among the highest in the region when measured as a percentage of GDP, among other reasons.”

“The second thing is that the institutions that manage economic policy have not been contaminated. The Central Reserve Bank is a solemn and independent institution and has been for three decades now. With some ups and downs, the Ministry of Economy and Finance has generally maintained a responsible fiscal policy, unlike in other countries in the region, such as Bolivia, Argentina, or Brazil. These are not just figures; history and credibility count.”

“The third thing is constitutional padlocks. In Peru, the damage that a bad government or a bad Congress can do to the economic foundations is limited by the Constitution, and the markets know that.”

“Obviously, much damage can be done without necessarily changing the Constitution. Still, the big mistakes typical of Latin American countries – such as financing public spending with monetary emissions or expanding public enterprises- are restricted in the current Constitution.”

“This indirectly limits the potential fiscal deficit gap in the medium and long term”.

Economist and academic Marco Ortiz also gave his view on why economic stability is maintained in Peru despite the social hecatomb:

“In the 90s, a series of reforms occurred that gave constitutional rank protection to the Central Reserve Bank. That is to say, the Constitution guarantees the Central Bank its independence. Therefore, any political change that does not imply a constitutional reform is not considered a severe danger for the country’s macro-financial situation”.

“Furthermore, fiscal limits were included towards the end of the 1990s, which limit the spending capacity of incoming governments.”

“The Central Reserve Bank of Peru’s economic management is internationally respected. The figure of Julio Velarde, president of the entity, is significant, and the quality of the BCRP’s technical team matters a lot. Investors are reassured that there will not be abrupt jumps, for example, in the exchange rate.”

“In 2021, the country suffered a capital outflow of US$17 billion after Pedro Castilo’s victory. The BCRP intervened by providing liquidity and hedging through foreign currency derivative instruments.”

ARGENTINA’S FRAGILITY AS A COUNTERPART

As mentioned above, one of the counterparts seen in the region is Argentina, where every political crisis unleashes an economic and financial catastrophe.

When asked why this difference occurs, the Argentine economist and director of the Ledesma consulting firm, Gabriel Caamaño Gómez, considered:

“There are countries in which there is an institutional scaffolding and a certain orientation of economic policy that does not go into crisis or is not subject to 180° turns with a change of government. This is the result of a fairly stable social consensus”.

In contrast to what was mentioned in the preceding paragraph, Caamaño Gómez stated that in Argentina, “the average voter one day tells you that everything must be privatized and four years later he asks to re-establish”.

He said: “The pendulum swings from one extreme to the other; it is very volatile”.

For his part, Leonardo Chialva, another Argentine partner at Delphos Investment, pointed out that the significant difference between his country and Peru is that in the latter, there are solid “institutions” and “technicians in charge of the key agencies” and not “politicians in office”.

With information from Bloomberg

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