Weak Economy and Political Paralysis Warrant Caution With Peru

new peru

The entire cabinet resigned this month.  Political paralysis and a weak growth trajectory keeps us cautious on Peru. 

POLITICAL OUTLOOK

President Kuczynski just completed the first year of his 5-year term.  Term limits will prevent him from running for reelection.  Whilst widely respected by the markets, Kuczynski has had trouble governing as he is the first president without a majority in congress.

The opposition holds a majority of seats in congress.  Fuerza Popular (FP) is headed by Keiko Fujimori, who narrowly lost to Kuczynski in 2016.  FP has worked hard to frustrate the government’s legislative efforts in congress, obviously with an eye towards helping Fujimori win the next election.

The next national elections will be held in June 2021.  Keiko Fujimori is likely to be the FP candidate, though her brother Kenji may end up mounting a challenge to her party rule.  Veronika Mendoza of the leftist Nuevo Peru party came in third last year, and is likely to run again.

Municipal and regional elections will be held in October 2018.  Note Kuczynski’s approval rating dropped 7 percentage points to a new low of 22% in the latest Ipsos poll, which was taken from September 13-15.  If he cannot turn it around by next fall, his party is likely to do poorly.  These local polls could be a good barometer for the 2021 elections, though we note that the gap between the two is quite long.

A cabinet shuffle was forced this month after a vote of confidence failed.  Vice President Araoz was named cabinet chief after her predecessor lost the vote.  Deputy Economy Minister Cooper was named Finance Minister.  The confidence vote was called to try and stop the opposition from forcing out the fourth minister in less than a year, this time in response to a protracted teachers’ strike.  Kuczynski also replaced his justice, education, health and housing ministers.

Peru scores very well in the World Bank’s Ease of Doing Business rankings (54 out of 190 but down from 53 in 2016).  Its best components are getting credit and registering property, while the worst are starting a business and paying taxes.  Peru does less well in Transparency International’s Corruption Perceptions Index (101 out of 176 and tied with Gabon, Niger, the Philippines, Thailand, Timor-Leste, and Trinidad & Tobago).

ECONOMIC OUTLOOK

The economy is still sluggish.  GDP growth is forecast by the IMF to decelerate to 3.5% in 2017 from 3.9% in 2016, before picking up to 3.7% in 2018.  GDP rose 2.4% y/y in Q2, up from 2.1% in Q1 but still historically slow.  Monthly data so far in Q3 suggest some modest slowing, and so we highlight downside risks to the growth forecasts.

Price pressures bear watching, with CPI accelerating to 3.17% y/y in August from 2.85% in July.  This was the highest rate since April, and moves inflation back above the 1-3% target range.  Central bank President Velarde said expects September and October CPI to fall m/m, and noted that higher inflation has prevented it from cutting rates quicker.  Given the high base effect from 2016, the y/y rate should fall substantially and back within the target range.

Still, the data didn’t stop the central bank from cutting rates again this month.  Peru delivered a dovish surprise 25 bp cut to 3.5% at that meeting.  The bank appears to comfortable cutting rates 25 bp every other meeting.  If this pattern holds, then we should see steady rates at the October 12 meeting and another 25 bp cut at the November 9 meeting.  We believe easing will continue in early 2018.

Fiscal policy has remained prudent despite low commodity prices.  A structural budget rule was first introduced in 1999 and then updated in 2013.  The budget deficit came in at an estimated -2.7% of GDP in 2016.  It is expected to widen to -3% of GDP in 2017 and -3.3% in 2018.  Higher copper and gold prices should help boost government revenues, but this will be offset by sluggish growth.

The external accounts should improve.  Low commodity prices have hurt exports, but the sluggish economy has helped reduce imports.  The current account deficit was about -2.7% of GDP in 2016, and is expected by the IMF to narrow to around -2% in both 2017 and 2018.

Foreign reserves have steadied after falling over the course of 2013-2015.  At $62.2 bln in May, they cover 14 months of import and are nearly 8 times larger than the stock of short-term external debt.  This low external vulnerability is amongst the best in Latin America and EM as a whole.

INVESTMENT OUTLOOK

The sol has held up after a strong 2016.  In 2016, PEN rose 1.5% vs. USD and was behind only the best performers BRL (22%), RUB (+20%), ZAR (+13%), COP (+6%), CLP (+5.5%), IDR (+2%), and TWD (+2%).  So far in 2017, PEN is up 3% YTD and is one of the better EM performers.  The best are MXN (14%), THB (7%), SGD (6.5%), TWD (+6%) and MYR (+6%).  Our EM FX model shows the sol to have STRONG fundamentals, so this year’s performance is likely to continue.

USD/PEN couldn’t sustain a break below 3.2300 and has turned higher.  The low for this move was recorded on September 11.  USD/PEN is already above the August high and is on track to test the May high near 3.30.  Using the January-September drop, retracement objectives come in near 3.2920 (38%), 3.3120 (50%), and 3.3320 (62%).  The 200-day MA comes in near 3.27.

 Peruvian equities are performing with the rest of EM after a stellar 2016.  In 2016, MSCI Peru jumped 52% vs. 7% for MSCI EM.  So far this year, MSCI Peru is up 25% YTD and compares to 25% YTD for MSCI EM.  Peru should start underperforming more, as our EM Equity model has the country at a VERY UNDERWEIGHT position.

Peruvian bonds have outperformed this year.  The yield on 10-year local currency government bonds is -113 bp YTD.  This is behind only the best performers Brazil (-156 bp) and Indonesia (-138 bp).  With inflation likely to resume falling and the central bank likely to ease further, we think Peruvian bonds will continue outperforming.

Our own sovereign ratings model shows Peru’s implied rating steady at BBB+/Baa1/BBB+.  As a major copper exporter, the fall in prices has fed through into weaker fundamentals.  However, the outlook has improved and actual ratings of BBB+/A3/BBB+ appear safe from downgrade risks.