peru seeing is believing (3)

8/2/2019 Peru Seeing is Believing (3)

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EMERGING MARKETS RESEARCH 8 March 20

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 5

PERU

Seeing is believing

Even though President Humalas popularity has recovered after the intensificationof social conflicts at the end of last year, businesses seem to remain incredulous

about the governments capacity to face the countrys challenges.

Business confidence has remained relatively low despite some recovery in recentmonths, which continues to limit investment growth. Attention is concentrated

on the future of the mining project Conga. Businesses are waiting for the final

outcome of this case as a signal of the business environments outlook.

Despite the political risk we perceive and the economic implications it mighthave, the countrys fundamentals remain strong. Even though we expect an

acceleration of public expenditures, we still think the public sector will register

surpluses in the next two years.

We maintain a neutral position in our credit portfolio for Peru. The spreads are tightcompared with other low betas in the region, and the balance of risk is skewed

negatively: spreads could underperform if social conflicts escalate, but their

outperformance is likely to be limited if the situation remains unchanged.

Is Humala gaining governability?

In Growth threatened by social conflicts, The Emerging Markets Quarterly, December

6, 2011, in the context of increased protest surrounding key mining projects, we

highlighted the risk of a negative effect on economic activity from an increase in the

number of conflicts. Since then, President Humalas popularity has recovered, which

could be interpreted as a gain in governability after the crisis created by the paralyzation

of the mining project Conga, which led to a reshuffling of the cabinet at the end of last

year. Nonetheless, the number of social conflicts has been increasing, which suggests

to us that the risks remain latent there, while the government still seems to face the

task of proving its ability to deal with the countrys challenges.

Seven months after his inauguration, Humalas popularity remains relatively high by

Peruvian standards. Compared with an Ipsos-Apoyo August poll conducted after his

inauguration, his approval rating has gained 4pp, reaching 59% and exceeding the level

that his predecessors Alan Garcia and Alejandro Toledo had at the same stage of their

administrations by 9pp and 31pp, respectively (Figure 1). Nonetheless, when analyzing his

performance by socioeconomic strata, we can see that the increase is partly explained by

a rise among the higher income population, from which Humala reaches a 75% approval;

meanwhile, he has registered a 7pp decline in the lowest income population, which was

his original political base. The persistence of this trend could certainly weaken the political

support of the government and create some governability problems. However, despite

this decline, Humalas leadership still seems considerably strong, enjoying an approval

Alejandro Arreaza

+1 212 412 3021

[email protected]

Alejandro Grisanti

+1 212 412 5982

[email protected]

Donato Guarino

+1 212 412 5564

[email protected]

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Barclays Capital | Peru: Seeing is believing

8 March 2012 2

rating above 55% in all segments of the population. Moreover, given the First Lady Nadine

Heredias high popularity and influence in government decisions, markets should considerher and her eventual successor, while we think the possibility of a constitutional reform to

introduce reelection (a fear that rose during the electoral campaign) has decreased.

The risks ahead come from the persistence of structural factors, such as weak institutions

and the lack of a state presence in certain regions of the country, which could tend to

undermine governability. For instance, given the existence of rising rents from mineral

extraction, voters who gave Humala a mandate to increase redistribution are likely to

intensify their demand and, eventually, if not satisfied, withdraw their political support. In

such circumstances, threatened by already visible frictions inside his government coalition,

a return to the populist road could still be a temptation. Time will tell, but this is something

that market participants should be aware of when considering Perus credit profile, in our

view, especially taking into account its high valuation.

Weak confidence breaks investment

Despite President Humalas high approval rating, it has not been possible for the

government to totally recover business confidence, which has led to the persistent

deceleration trend in economic activity (Figure 3), given a slower contribution of investment

to growth. GDP growth fell from 7.8% in H1 11 to 6.1% in H2, and we expect this trend to

continue in 2012, estimating a growth of 5.8% mainly supported by persistently strong

consumption and a rebound of public expenditures. Certainly, this GDP growth continues to

be relatively high; however, unless there is a recovery in investment, a lower capital

accumulation could reduce potential growth. This could also weaken job creation, which

could undermine the strong consumer confidence that is supporting consumption growth.

In this context, the future of the mining project Conga has more importance than a USD6.9bn

investment over the next four years. Businesses are waiting for the final outcome of this case

as a signal of the business environments outlook. That means that weak investment

confidence could affect economic activity for most of the year, considering that, in the past, a

recovery in economic activity after a decline in confidence has had a lag of three to five

months. The projects environmental impact is being reassessed by international experts.

However, beyond the technical arguments about the projects viability, the situation has

become increasingly politicized, which heightens the possibility that the involved parties will

hold their views and just use parts of the experts assessments that support their positions.

Figure 1: Humalas popularity vs his predecessors (%) Figure 2: Increasing number of social conflicts

25

30

35

40

4550

55

60

65

70

1 2 3 4 5 6 7

Humala Garcia Toledo

210

215

220

225

230235

240

245

250

255

Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12

Social conflicts

Source: Ipsos-Apoyo Source: Peruvian Ombudsman

In a scenario in which

Humala could lose political

support, a return to the populist

road could still be a temptation

Business confidence

has remained relatively low,

which continues to limit

investment growth

Social conflict is not

unfamiliar in Peru; however, as

the stakes increase, conflicts

tend to intensify, deteriorating

the business environment


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8 March 2012 3

Assuming that the government holds the position taken by President Humala that Conga

should be carried on, the project might move forward, but conflicts are likely to continue too.Certainly, social conflict is not unfamiliar in Peru; however, as the stake increases, the risk is

that the conflicts tend to intensify, deteriorating the business environment.

Above all, fundamentals remain strong

Despite the political risk we perceive and the economic implications it might have, the

countrys fundamentals remain strong. The rapid increase in government revenues due to

still relatively high growth and favorable commodities prices, as well as expenditures cut

due to the withdrawal of the fiscal stimulus implemented after the 2008 crisis, has led to a

significant improvement in the fiscal balance. Last year, the public sector registered a

surplus of 1.8% of GDP. Even though we expect an acceleration of public expenditures that

would deteriorate the fiscal balance, we still expect it to register surpluses in the next two

years (1.0% and 0.6% of GDP in 2012 and 2013, respectively). This, coupled with the

growth outlook, is expected to hold the decline to around the 20% of GDP level.

There has also been an improvement on the external front, with the current account deficit

declining from 1.7% in 2010 to 1.3% in 2011. This improvement was also supported by the

better-than-expected performance of non-traditional exports. Given a moderation in mineral

prices, we expect a deterioration in the current account balance and estimate a deficit of 2.0%

of GDP in 2012; however, this is more than compensated for by the FDI flow. To mitigate the

appreciation pressures, the BCRP has maintained a strong FX intervention. In the first two

months of the year, it already purchased USD3.7bn, with an average of USD85mn per day, six

times the average in the same year-ago period. We expect this intervention to be reduced in

the coming months; however, we think the reserve position will likely keep growing andexceed USD56bn by the end of the year, approaching 30% of GDP, which will leave the

country in a strong position in case of an eventual lower capital inflow.

In terms of inflation, as growth slows, we expect a progressive moderation in prices during

the year to return it to the target range. However, strong consumption has allowed

producers to transfer higher costs to the consumer despite slower demand growth, and

higher energy and food prices could be a risk ahead. Therefore, even if the economy is

decelerating, we do not expect monetary stimulus as long as inflation remains above the

upper bound of the target and GDP remains close to potential. We still expect the BCRP to

Figure 3: Weak business confidence undermines growth Figure 4: Still strong fundamentals (% GDP)

30

35

40

45

5055

60

65

70

75

Aug-07 Apr-08 Dec-08 Aug-09 Apr-10 Dec-10 Aug-11

-4

-2

0

2

46

8

10

12

14

Industrial Confidence GDP

15.0

17.0

19.0

21.0

23.0

25.027.0

29.0

31.0

33.0

35.0

2006 2007 2008 2009 2010 2011 2012F 2013F

(2.0)

(1.5)

(1.0)

(0.5)

0.0

0.51.0

1.5

2.0

2.5

3.0

Fiscal balance (RHS) Public debt

Source: INEI, Barclays Capital Source: INEI, Barclays Capital

Public sector is

expected to register surpluses in

the next two years and keep

reducing indebtedness level

Monetary stimulus is

not expected as long as inflation

remains above the upper bound

of the target and GDP remains

close to potential


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8 March 2012 4

keep the monetary policy rate unchanged during the year and rely more on the fiscal

stimulus to contain further deceleration of the economy. As long as the cause of the growth

moderation is a confidence shock, an interest rate cut might not be effective enough to

stimulate investment and reaccelerate growth.

Strategy: Balance of risks not favorable; we remain neutral

We maintain a neutral position in our credit portfolio for Peru. Despite strong fundamentals,

price action has been dominated by political risks well before the election. Indeed, while

debt metrics have been enviable, Peru's bonds volatility has increased considerably over the

past year compared with other low-beta credits at first because of the political

uncertainty of the Humala administration and more recently due to the intensification of the

social conflicts.

While we do not think the current conflicts pose a threat to the ability to repay USD debt,

they may increase the risk premium, which could negatively affect performance. Hence,

since Perus long-end bonds are trading only 20-25bp wider than other Latin American low-

beta credits (Brazil in particular), we think this is fair to marginally expensive and remain

neutral while awaiting further developments. In our view, the balance of risk is skewed

negatively: spreads could underperform if social conflicts escalate, but outperformance is

likely to be limited if the situation remains unchanged.

On the bond curve, in line with our sovereign credit strategy, we recommend extending

exposure to the long end of the curve, which remains steep by historical standards because

of the recent supply. Indeed, new supply is unlikely, in our view, because Peru just re-tapped

the PE50s for more than USD500mn. Furthermore, the long-end spread remains attractive,

especially in a supportive global environment that we consider our base-case scenario for

the next quarter. Finally, we are not overly concerned about US Treasury movements, which

should remain range-bound; hence, they should not be a risk for spreads. Our favorite picks

are the PE33s and PE50s.

The balance of risk is

skewed negatively: spreads

could underperform if social

conflicts escalate

Figure 5: Perus premium to Brazil is marginally higher thanpre-election crises levels

Figure 6: PE33s and PE50s still the cheapest bonds on thecurve

-20

-10

0

10

20

3040

50

60

70

80

90

Jan 10 Jul 10 Jan 11 Jul 11 Jan 12

Peru 37s - Brazil 41s Average

PE 16 PE 19

PE 25

PE 33PE 37

PE 50

80

100

120

140

160

180

200

220

240

2.00 4.00 6.00 8.00 10.00

Duration

Spread (bp)

Source: Barclays Capital Source: Barclays Capital


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8 March 2012 5

Figure 7: Peru: Macroeconomic Forecasts

2008 2009 2010 2011 2012F 2013F

Activity

Real GDP (% y/y) 9.8 0.9 8.8 6.9 5.8 6.0

Private Consumption (% y/y) 8.7 2.4 6.4 6.3 6.3 5.8

Private Fixed Capital Investment (% y/y) 25.9 -15.1 22.1 11.7 7.5 8.0Exports (% y/y) 8.2 -3.2 1.3 8.8 6.8 6.2

Imports (% y/y) 20.1 -18.6 24.0 9.8 7.7 8.7

GDP (USD bn) 127.4 126.8 155.2 176.4 196.1 216.0

External Sector

Current Account (USD bn) -5.3 0.2 -2.6 -2.3 -3.8 -4.1

CA (% GDP) -4.2 0.2 -1.7 -1.3 -2.0 -1.9

Trade Balance (USD bn) 2.6 6.0 6.8 9.3 8.9 6.9

Net FDI (USD bn) 6.2 5.2 7.1 7.5 7.9 8.3

Gross External Debt (USD bn) 34.8 35.7 40.5 43.2 46.5 49.5

International Reserves (USD bn) 31.2 33.2 44.1 48.8 56.7 62.9

Public SectorPublic Sector Balance (% GDP) 2.3 -1.6 -0.5 1.8 1.0 0.6

Primary Balance (% GDP) 3.7 -0.3 0.6 2.9 2.1 1.6

Gross Public Debt (% GDP) 24.0 27.2 23.2 21.7 20.1 18.7

Prices

CPI (% Dec/Dec) 6.7 0.3 2.3 4.7 2.9 2.3

FX (PEN per USD, eop) 3.14 2.88 2.80 2.73 2.64 2.65

1yr Ago Last 12Q2F 12Q3F 12Q4F 13Q1F

Real GDP (y/y) 8.8 5.7 5.5 5.8 6.3 6.0

CPI (% y/y, eop) 2.66 3.85 3.84 3.13 2.90 3.09

Exchange Rate (PEN per USD, eop) 2.80 2.67 2.66 2.65 2.64 2.64

Monetary Policy Benchmark Rate (%, eop) 3.75 4.25 4.25 4.25 4.25 4.25Source: BCRP, INE, Haver, Barclays Capital


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Analyst Certification(s)We, Alejandro Arreaza, Alejandro Grisanti and Donato Guarino, hereby certify (1) that the views expressed in this research report accurately reflect ourpersonal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will bedirectly or indirectly related to the specific recommendations or views expressed in this research report.

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peru seeing is believing (3)

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