Mon | Nov 19, 2018

Walter Molano | Peru: Beset by drama

Published:Friday | November 9, 2018 | 12:00 AM
A scene in Peru.

Peru is a mess. Well, not really.

The economy is expected to grow only four per cent this year. Inflation is under two per cent. The sol devalued 1.8 per cent during the first 10 months of the year. The current account deficit is expected to close the year at about 1.5 per cent of GDP, and the central bank has international reserves of about US$60 billion.

This is for a US$190-billion economy.

To put things in context, Argentina has reserves of US$49 billion. This is to cover an economy of US$545 billion. Nevertheless, the numbers confirm the complete economic disaster that reigns in Peru. Well, not really.

But, if you listen to most Peruvians, you would think that they were describing a situation akin to Iraq. Still, this level of self-criticism may be characteristic of some of the better performing economies in Latin America.

Just like Panama, the Peruvian economy has slowed from the heady pace of the past decade, but it is far from being in a crisis.

In actuality, Peru is one of the best managed economies in Latin America. Like its two Andean neighbours, Chile and Colombia, it is the picture of macroeconomic prudence and sobriety. Presidents may come and go in Peru.

A myriad of phone conversations, implicating judges and politicians, may be released. A family feud may convert one of the most storied political families in Peru into the laughing stock of the continent, but the Peruvian economy steams ahead, unperturbed by the daily dramas of its political class.

Like overachieving kids who experience panic attacks when they get a B+ on an exam, Peruvians and Panamanians make it seem like they are in the midst of an economic crisis. However, what they are really going through is a healthy slowdown in activity that will allow them to consolidate their economic gains, and to position themselves for their next phase of expansion.

Independent institutions

One of the things that allowed Peru to achieve its steady pace of economic expansion has been the independence of its financial and regulatory institutions. Although some of the other South American countries may look down their noses on Peru, it has one of the most independent central banks of the region. This has allowed it to manage monetary aggregates prudently.

At the same time, a high degree of dollarisation in the financial system has imbued the currency with a great deal of stability. For example, Colombia does not allow dollar deposits in the financial system. Therefore, any foreign currency inflows must be converted immediately into Colombian pesos. That means that a large influx of foreign direct investment can put a great deal of upward pressure on the currency.

The opposite happens when there are large outflows. However, this is not the case in Peru. Dollar deposits are allowed. That means that foreign investors can bring in and take out funds, without disturbing the exchange rate. Moreover, foreign investors can even do local transactions in foreign currency, such as purchasing land and equipment, without having to touch the exchange rate markets.

This is one of the reasons the Peruvian sol has been so stable, despite wild swings in most emerging market currencies. Peru also has a strong regulatory framework, particularly in the financial sector. And it has a large private pension fund system that provides local companies and the government with ample capital to meet their investment and operating needs.

All of these factors are essential in creating the stability that characterises modern-day Peru.

Nevertheless, there are some legitimate concerns about the upcoming general elections, less than two years away. The Odebrecht corruption scandal has laid waste to the political class, putting one former president in jail, impeaching another one and setting another one on the, lam. Now, the judicial system has fallen into the spider's web of corruption and entanglement.

Peru's traditional political parties collapsed during the economic crises of the 1980s, and they never recovered. However, the Odebrecht corruption scandals are undermining the public's trust in traditional political institutions, such as the executive, the legislative branch and judiciary.

This is a phenomenon that is sweeping the planet. Particularly in the wake of the global

financial crisis of 2010, many electorates gave up on the

traditional political class and opted for independents that sang a siren's song of easy fixes and empty promises.

Today, a wave of authoritarianism is spreading, as these unchecked populists transform themselves into dictators and tyrants. Peru runs a similar risk. So far, the electoral landscape is bare, and there are no contenders for the next presidential race. Nevertheless, a wave of independents will soon emerge, and they run the risk of moving the country into a completely new direction.

The Peruvian economy may be doing fine. Unfortunately, there is a great deal of legitimate uncertainty about the next presidential elections in 2020.

- Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com