Peruvian Outlook Solid Ahead of Weekend Election

Ballot box painted into national flag - Peru.jpg

After this coming weekend’s vote, the next president is unlikely to deviate from the long-standing pro-business model. The new administration will inherit an economy that is in good shape despite low copper prices, due to the nation’s adherence to sensible economic policies.

POLITICAL OUTLOOK

The second round of the presidential election will be held this weekend after the first round in April proved inconclusive. Keiko Fujimori won the first round with 39.5% of the vote, but fell short of the 50% needed to avoid a second round. She will face Pedro Pablo Kuczynski (second place with 23.7%) in the second round vote June 5. Leftist Veronika Mendoza came in third with 17.1% of the first round vote. This Monday, she endorsed Kuczynski, asking her supporters to help prevent a Fujimori victory.

The latest polls available (taken prior to Mendoza’s endorsement of Kuczynski) suggest Fujimori was opening up a lead. Latest Ipsos poll showed her ahead 53%-47%, a 6 percentage point lead with a +/- 2.3 percentage point margin of error. Latest GfK poll showed Fujimori having only a 3.8 percentage point lead and within its margin of error. However, Mendoza’s endorsement could be a game-changer that pushes Kuczynski ahead.

Kuczynski is a former Finance Minister and central bank director, and so has a lot of credibility with the markets. He ran for president in 2011 but came in third behind Humala and Fujimori. To state the obvious, Fujimori comes with some baggage but many voters clearly view her and her father in a positive light. If she wins, we suspect the country will become increasingly polarized.

Both Fujimori and Kuczynski are expected to continue with orthodox economic policies. Even outgoing President Humala ultimately hewed to the orthodox path, despite his populist platform. Yet Humala’s popularity is at all-time lows, hurt not only by the economic slowdown but by ongoing corruption scandals.

ECONOMIC OUTLOOK

The economy is finally picking up. GDP growth is forecast to accelerate modestly to around 3.5% in 2016 and 4% in 2017 from 3.2% in 2015. GDP rose 4.4% y/y in Q1. This was slightly weaker than expected, and was boosted by a low basis for comparison. Base effects for the rest of the year are higher and so less favorable for y/y comparisons.

The copper outlook remains poor. Charts suggest an eventual test of the January cycle low near 193.50. Due to the nature of commodity booms and busts, Peru is bringing several major mines online this year, even as copper prices approach the cycle lows. The Las Bambas mine started shipments to China early this year, and total output from Peru could eventually double production to 2.8 mln tons per annum. This should keep downward pressure on copper prices.

Price pressures are still easing, with CPI rising 3.5% y/y in May. This is the lowest rate since June 2015, and suggests that the next move is likely to be a cut. With inflation still above the 1-3% target range, however, easing is unlikely until H2. The central bank next meets June 9, and no change is expected. Indeed, the central bank has been on hold since the last 25 bp hike back in February took the policy rate to the current 4.25%.

Fiscal policy has remained prudent. Unlike many of the commodity exporters, Peru was well-prepared for the downside of the commodity cycle. A structural fiscal rule has kept spending under control, and so the debt stock remains one of the lowest in the region despite the economic slump. The IMF estimates that the budget deficit came in around-2.3% of GDP in 2015. It is expected to widen slightly to around -2.6% this year before narrowing in 2017.

The external accounts bear watching. Lower copper and gold prices have hurt exports, but low energy prices have helped reduce imports. The current account gap was about -4% of GDP in both 2014 and 2015, but is expected to narrow slightly in 2016. Foreign reserves have fallen modestly, but at $60.6 bln in May, they cover nearly 13 months of import and are about 9 times larger than short-term external debt.

INVESTMENT OUTLOOK

The sol has generally performed in the middle of the EM pack. In 2015, PEN lost -13% vs. USD. This compares to the worst performers ARS (-35%), BRL (-33%), ZAR (-25%), COP (-25%), and RUB (-20%). So far this year, PEN is up 1% YTD and is lagging the best performers BRL (+10%), RUB (+9%), and MYR (+3.5%). Our EM FX model shows the sol to have NEUTRAL fundamentals, so this year’s “so so” performance is to be expected.

Peruvian equities have outperformed this year after a poor 2015. Last year, MSCI Peru was -32% while MSCI EM was -17%. So far in 2016, MSCI Peru is up 33% YTD, and compares to 1% YTD for MSCI EM. This outperformance should ebb a bit, as our EM Equity model has Peru at a NEUTRAL position.

MSCI will rule on June 14 whether Peru will be downgraded to Frontier Market status from Emerging Market status currently. At issue is the steady decline in stock market liquidity in recent years, which leaves only three securities as “investable” by MSCI. On the plus side, MSCI last month kept Southern Copper (one of the three investable stocks) in its MSCI Peru index.

Peruvian bonds have outperformed this year. The yield on 10-year local currency government bonds is about -98 bp YTD. This is behind only Brazil (-371 bp) and ahead of Turkey (-88 bp) and Indonesia (-82 bp). With inflation likely to continue falling and the central bank’s next likely move to be a cut, we think Peruvian bonds will continue outperforming.

Our own sovereign ratings model shows Peru to be correctly rated at BBB+ by both S&P and Fitch. Moody’s seems to have been a bit premature in upgrading it by two notches to A3 back in July 2014. A one notch move to Baa1 would have been the better move then.