Risks heightened by Peru’s changing of the guard

Following the election of Pedro Castillo's Free Peru party, uncertainty about the political scenario and economic policy are hitting the country's risk ratings. Photo: Reuters.

Euromoney’s latest, second quarter country risk survey took place in the wake of the shock election victory in April for Pedro Castillo of the left-wing Free Peru party.

The former schoolteacher and union leader unexpectedly saw off the challenge from Keiko Fujimori of the right-wing Popular Force, to form a radical government that has already led to a spike in investor risks.

Its risk score sliding has seen Peru plunge five places in Euromoney’s global risk rankings, to 52^nd out of 174 countries, and deeper into the third of five categories of risk.

It may not be the last of it either, depending on what the government does, and how it goes about it. The portents are certainly rather ominous.

With the government only a month old, Castillo’s pick as foreign affairs minister, the octogenarian Hector Bejar, resigned in the wake of criticism over comments he made about historical terrorism.

Choosing as his replacement Oscar Maurtua, who held the role under the government led by Alejandro Toledo in 2005-2006, has already led to ructions within the new ruling party.

Unlike Uruguay (28^th), Paraguay (45^th), and even Guyana (51^st) – all improving in the survey and safer bets in the region – confidence is dissipating among the experts.

These include Bernardo Fernandez, a researcher in Bolivia, and Paul Mauricio Tola, an economist and credit risk manager at Banco Internacional Ecuador.

Both are Latin American regional experts focusing on Peru’s risks.

Expert voice

Fernandez mentions that, after the highly contested elections and narrow victory for Castillo, his first weeks as president have been marred by worrying political struggles, both within and outside his political party, Peru Libre.

This is an important element for investors to digest.

“Internally, Castillo has so far been unable to establish a sound and cohesive ministerial cabinet.

“The influence of the ruling party leader [Vladimir] Cerron and prime minister [Guido] Bellido, both known for their radical socialist stance, is somehow clashing with Castillo´s attempts to show a more moderate approach in sensitive areas such as the economy and Peru´s international relations, mainly to restore confidence among economic agents and preserve the pace of the ongoing post-pandemic economic recovery.”

Fernandez says the designation of Pedro Francke as the minister of finance and Maurtua as minister of foreign affairs was well received in the financial markets but there are still concerns about the cabinet appointments, with some other ministers having alleged connections to extremist groups or well-known cases of corruption.

This scenario would imply a persistent political confrontation between congressmen and the executive branch that, in the worst case, could cause a break-up in the institutional order 

 - Mauricio Tola

Outside his party, too, Castillo faces “a highly polarized political scenario implying that many significant changes he had offered during his campaign – including establishing a Constitutional Assembly to modify the Peruvian constitution – will face significant obstacles in a divided Congress, making governance quite challenging.”

Tola agrees, stating that the designation of Bellido – on the radical left – as the leader of the cabinet, plus some of the announcements by president Castillo, have caused important concerns on diverse forums.

“Some of these announcements refer to the increasing participation of the government in strategic sectors, the possible establishment of a commission to manage the exchange rate in the local market, and the proposal to regulate interest rates among domestic financial institutions.

“This scenario would imply a persistent political confrontation between congressmen and the executive branch that, in the worst case, could cause a break-up in the institutional order,” he says.

In this context, local analysts are projecting a lower trajectory for GDP in 2022, due to increased uncertainty about economic policy, the lag on public and private investments, less confidence in the currency and the loss of foreign capital, among other factors.

Volatility

Fernandez notes that the political chaos has already sparked currency volatility, causing the Peruvian sol to depreciate substantially against the US dollar in recent months to levels not seen for three decades. Deteriorating confidence has also hit the local stock exchange, although the recent announcement of a possible reshuffle of the ministerial cabinet cut some of the losses.

Tola says that despite the continuation of Julio Velarde (an experienced central banker) as director of the Banco Central de Reserva del Perú, and appointment of the moderate left Francke as minister for economy and finance, the uncertainty about the political scenario and economic policy (especially the proposals from Bellido) means that analysts are suggesting the exchange rate could go to a minimum of 4 USD/PEN until December 2021, even if the central bank is active on the market.

Both analysts are more confident about the economy on the back of reviving commodity prices, underlined by a small recovery to most of the survey’s economic risk factor scores.

Tola mentions that copper prices have been decreasing since May 2021, but the current value is significantly higher in comparison with last year.

Regarding oil prices, future values show the current trend will continue relatively the same until December 2021. This situation, he says, may mitigate potential deviations in the gold price trend that could negatively affect exports.

Consequently, Peruvian exports would tend to keep their value during the second half of 2021 with respect to current flows and that would be the case even if the economy is affected by a moderate outbreak of the coronavirus pandemic.

Castillo´s political decisions in the following weeks will be crucial for the following years 

 - Bernardo Fernandez

Fernandez is also at pains to point out that, unlike Chile, Ecuador or Bolivia, “Peru has a much more diversified portfolio of commodity exports supporting its recovery and “[its] industry has demonstrated high levels of resilience to political crises in recent years.”

However, Tola also mentions fiscal risks. While pending and urgent investments in the healthcare system are merited, the government has plans that include “investing in strategic sectors, supporting agricultural development programmes, increasing social protection campaigns and offering a greater portfolio of public services”.

All of this would lead to an expansion of the fiscal deficit, which could also see interest rates rise.

Fernandez, meanwhile, comes back to the fundamental problem of political risk.

“Plans to write a new constitution (as in Venezuela, Bolivia and soon Chile) add more risks in the near future, especially if such an initiative hinders the independence of some institutions – such as sectoral regulators or the central bank – supporting the economy.”

He goes on to note that, “Castillo´s political decisions in the following weeks will be crucial for the following years.”

Peru’s falling risk score is certainly reflecting these risks, and given that, investors cannot say they were not warned.