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Investors eyeing Peru, South America’s fastest-growing economy over the last half-decade, remain cautiously optimistic that newfound president-elect Ollanta Humala, the former army officer who officially takes to the stage this week, is more bark than bite vis a vis alleged socialist leanings: the overall moderate ideology of recent economic team appointments, for instance, suggests more pragmatism than populism, though the ambiguity of an impending mining sector profit windfall tax regime saw the proportion of private sector firms considering increasing investment in the next six months decline from more than 50% in Q1 11 to approximately 10%. This private investment pullback, in fact, combined with the lingering effects of contracting public expenditures (20% government-project capex reduction over the first four months of the year) stemming from the relatively restrictive election-time, legal framework, should contain inflation in the near-term (~3.0% in 2011 and 2.5% projected in 2012) though at the expense of the output gap, a dynamic which analysts expect will slash GDP growth from 8.8% last year to roughly 6.5% in 2011 (confirmed by the recent slowdown in the consumption of durable goods and investment) and around 5% next year. What will be interesting to monitor, therefore, is the extent to which Humala’s policy agenda moderates (the minimal gasoline price increase, which left prices 16% below international prices per analysts, was a start) to compensate–a phenomenon which should translate into a public sector balance deficit (as a % of GDP). At the same time, monetary policy (current rate is 4.25%) should remain dovish given the slackening backdrop, meaning said deficit’s inflationary effects over the longer-term could be somewhat amplified. Yet fiscal expansion should not necessarily be viewed negatively; not only is Peru sitting on a sound fiscal foundation (expected gross public debt of ~22% of GDP and a reserves to external debt ratio of 1.12x), but spending could go a long ways towards reversing an inequality gap that appears to be boiling over: observers note that in January 2010, 35% of the social conflicts presented at least one event of violence, while in May 2011, this proportion increased to 51%, causing analysts with Barclays to remark last month that “Peru’s socioeconomic conditions and institutional weaknesses show the need for greater government presence in areas in which it currently lacks and in which all these social conflicts clearly emerge.” Let the juggling act begin.
Markets hate uncertainty and Tuesday’s price action in EPU, Peru’s index fund, was indicative of such as investors eagerly eye Sunday’s impending Presidential run-off. Interestingly, though Fujimori may be considered “more pro-business than the leftist candidate Humala” other observers point out that in fact “Keiko has few incentives to govern democratically, while Humala faces constraints that may force him to govern democratically.” Meanwhile The Economist somewhat brazenly slags the entire lot off, opining that regardless of who emerges “the single-minded pursuit of foreign investment and economic growth that marked [outgoing President Alan] García’s presidency now seems to be drawing to an end [and] many Peruvian democrats will have nightmares in the coming weeks.” A bit much, no? Peru remains one of the fastest growing countries in the world, up 8.8% annually in 2010 (the BRIC median, for comparison) and projected by Barclays to trail only China for current year domestic output on the back of hitherto both monetary and fiscal stimulus. Moreover the central bank (BCRP) has not overly lagged the curve (per Taylor’s Rule) and prices remain in line with the targeted 3% upper band; the 25bp hike on May 12 (to 4.25%), while below expectations, was more a commentary on the relative slowdown to date and the private sector’s risk averse approach to the election run-up whereby GDP proxies such as electricity consumption and cements sales have visibly dipped. To this end, policy rates should tighten fairly substantially post election to 5.5% by year’s end and, per Barclays analysts, will likely be more front-loaded in the event Fujimori wins. That said, they write, whomever wins will need to navigate the country away from a purely economic and more towards a social agenda: “Peru’s socio-economic conditions and institutional weaknesses explain why, despite impressive growth over the last several years, Mr. Humala’s seemingly radical proposal continues to appeal to a third of the population.” While ominous sounding, it’s hard to completely divorce oneself from a pragmatic central bank in a high growth economy, especially when copper may finally look healthy again. More uncertainty.
The Peruvian sol took a step backwards on Friday after rising 0.9% on Thursday to 3.2071 soles, rebounding from a two-year low as the central bank bought $60 million worth of the currency. The sol was up from 3.237 on Wednesday, but closed back down on Friday to 3.2108.
The central bank has purchased $241 million worth of soles so far this month, but at least some punters suspect that the currency must still catch up with its Latin American counterparts that have depreciated more in the past six months. The sol has dropped 13% since August, for example, against 31% plunges in both Brazil’s real and Mexico’s peso.
“There’s more demand from local and foreign banks for short-term forwards of 30-, 60-, 90-days, up to a year,” Ricardo Villamonte, the head of currency trading at Peru’s largest lender, Banco de Credito, told Bloomberg. “They see the sol behind other currencies in the region. There’s a trading opportunity.”
Per The Economist, “the fastest growing of the larger economies in Latin America [in 2009] will once again be Peru, not least because the government will keep faith in free trade, rather than the socialism fashionable elsewhere.” To that extent, Peru and the U.S. have implemented a free-trade agreement, one of several promoted by the U.S. to counter rival proposals by Venezuela’s President Hugo Chavez. Nonetheless, Peru’s President Alan Garcia is suffering from a ratings slump (though he just announced a $3 billion economic stimulus plan) that some pundits attribute to such liberalized economic policies. From The Council on Hemispheric Affairs this past October:
Despite Peru’s impressive recent economic development – 83 months of consecutive growth as of May 2008 – its civil society is becoming increasingly discontent with the leadership of Alan García. Reuters news service reported that while the country’s GDP growth rate hit 9.37 percent this year, the president’s personal approval ratings sunk to 19 percent. These ratings reflected a 16 point drop in the last four months alone, as protests and strikes over the FTA’s provisions have attracted a significant following. On October 7th labor groups across Peru organized a nationwide strike protesting the government’s economic policies, specifically accusing them of failing to alleviate poverty. According to the BBC, thousands of protesters marched in the nation’s capital and called for García’s entire cabinet to resign. As the President continues to lose legitimacy and popular unrest surges, fewer and fewer Peruvians are accepting the notion that the global free market will increase their odds of gaining prosperity.
That said, with expected (albeit slowing) growth of 6.4%, and inflation a (relatively) low 5%, a frontier investor could do worse than parking a portion of his or her money in Peru. Like that of Chile, Peru’s government has room to spare vis a vis public spending (i.e. credit lines and sector bailouts) given its savings of mineral revenues. The government is also continuing with its plans to sell its first foreign bonds in almost two years to “demonstrate the economy’s strength” after receiving investment-grade ratings. In doing so Peru would follow Mexico, which recently became the first developing nation to tap international debt markets since the global credit crisis deepened. Peru is also seeking to establish benchmark bond yields that would help its companies sell debt abroad.
Peru’s Lima General Index has not been spared by any means (see chart below), but the point here is that it represents a relatively attractive entry point (along with Chile) vis a vis Brazil, for example, where growth will be 2.7% in the coming year as tighter fiscal and monetary policy will squash consumer spending and curb growth.
The backbone of Peru’s economy is mining–it is the world’s largest silver miner and third-biggest copper producer (though textile, agriculture and energy related exports are also certainly vital to its continued growth). On that front, Canada announced last week that it will spend 4 million more U.S. dollars in the next three years to help promote its mining industry’s contribution to Peru’s sustainable growth. According to a bilateral memorandum of understanding, Canada agreed to extend the Peruvian-Canadian Cooperation Program (PERCAN) for another three years, to end on Dec. 31, 2011. Through its Agency for International Development, Canada will increase financial support to Peru’s mining industry to 13.6 million U.S. dollars from the 9.6 million dollars originally agreed under PERCAN. The extension of the program will strengthen Peru’s efforts to make its mining industry environment-friendly, thus contributing to the country’s sustainable growth. “As for environmental issues, we have brought the regulations closer to meeting international standards,” said Felipe Isasi, Peru’s vice minister of mining.
Interesting story in this week’s Economist (“Preparing for tougher times”) underlines a plethora of dour economic forecasts for Latin American economies heading into 2009:
In the past two months, Latin America has seen its stockmarkets crash, currencies wobble and credit start to dry up. That comes on top of falling exports and the plunge in the prices of the commodities it sells to the world. Twisting the knife, less money is being sent home by Latin Americans working abroad.
As recently as October, the IMF expected growth in the region next year of 3.2%. This week the World Bank forecast 2.1%. The same day Morgan Stanley, an investment bank whose Latin American research team is among the more pessimistic about the region, cut its forecast for the seven largest economies in 2009 from growth of 1.5% to a contraction of 0.4% . . . Two things lie behind the bleaker outlook. The first is the continuing steep fall in commodity prices because of worries that China’s economy is stalling. Commodities, from Venezuelan oil to Peruvian minerals, Argentine soya and Brazilian iron ore and orange juice, make up a big chunk of the region’s exports. The second dampener is that banks in Latin America have turned cautious. Many foreign banks are cancelling credit lines to the region, or renewing them for shorter periods or at higher rates. That may be to shore up their battered finances at home, but local banks seem to be following suit.
With that said, the piece admits that “the average conceals wide variations.” For example, while most nations do not have the required reserves necessary to increase government spending in order to spark future higher growth, “Chile is the big exception, having saved $21 billion derived mainly from windfall copper revenues in reserve funds. Its government has unveiled stimulus measures worth $2 billion, including credit lines for small and medium business and, less sensibly, sectoral bail-outs for salmon farmers and housebuilders.” And to a smaller extent, the article notes, Peru also has breathing room vis a vis public spending.
One interesting financial stock is Banco de Chile (NYSE: BCH), which was pretty beat up at the start of the year, but since received an upgrade from Deutsche Bank back in June from Hold to Buy due to expected greater earnings power following the acquisition of Citibank Chile. Its P/E of around 9 is less than Banco Santander-Chile (SAN). Both banks, by the way, were among the top gainers for banks (based on earnings) on the American continent for the third quarter of 2008.
Peruvian miner Buenaventura (Compania De Minas Buenaventura S.A.A.) (NYSE: BVN), with a market cap of USD 3.96 billion, is Peru’s largest publicly traded precious metals company.
While there are certainly a lot of Gold bulls screaming “Inflation” at the moment, it could in fact be the mining stocks rather than the commodity per se that are in for a positive adjustment heading into 2009. As one commentator on Seeking Alpha noted yesterday:
The XAU/Gold ratio is a measure of index of leading gold mining companies (XAU – Philly Gold and Silver Sector Index) relative to gold price. Over the past 25 years, the XAU/Gold ratio has been 0.25. That means the XAU index would be about ¼ the price of an ounce of gold.
On Monday (Dec. 8), the XAU closed at 94 while gold closed at $760 an ounce. This makes the XAU/Gold 0.124. That’s less than half the ratio’s long-run average and just off the 25-year lows.
The theory states that mining stocks got pushed down relative to bullion when the cost of oil spiked, but the market failed to readjust when the price of oil declined. Furthermore, gold stocks have tended to outperform in recessions. Finally, the artificially propped up dollar–due to quantitative easing and Asian largesse–is due to unwind. All of these factors together certainly point to gold stocks as being a tip-top stocking stuffer this season. Although coal stocks have taken a beating as well…