Finance Tightens — Peru joins the Troubled Ten

By Nicholas Asheshov

Morgan Stanley has told its clients that its MSCI division, which monitors international markets, is preparing to downgrade Peru from EM, Emerging Market, to Frontier status.

MSCI has also expanded its Fragile Five 2013 list —Brazil, Turkey, India, Indonesia and South Africa— to its Troubled Ten for 2016, to include also Peru, Colombia, Chile,  Malaysia and Singapore.   MSCI says these countries have new and above-average currency risks.  These countries will have increasing difficulty in covering their current account deficits, meaning that debt payments plus imports will be  higher than today’s low, slow income from exports.

The party is over.

For Peru it was a good one, by far and away the best in memory.  During the first dozen years of this century it catapulted Peru into a respectable new level of economic growth and management.  An urban middle class expanded by millions.  Poverty in the Andes dropped by millions.   Pay levels and property values doubled.

But today in 2015, the rapid growth of China that helped Peru, Brazil and a score of others to flourish is finished.  This was signaled last week by an initial 4.4% devaluation of the Yuan, the Beijing currency.  It was this that woke up the Wall St. analysts even though the slowdown had started a year ago.

The practical effect is twofold.

One is that China is saying it will need less and pay less for oil, gas, copper, iron ore, lead, zinc, gold and silver.  Second, it means that for the coming few years at least, China will be growing not at seven percent, much less the ten percent of earlier years, but more like one or two percent.  This is the new normal, like the United States struggling to get higher than two percent a year, Europe which cannot get yet to one percent.   China is joining them, just another shambling mammoth.

Peru, though no monster, marches to the same drumbeat.  A remarkable part of the past couple of decades, here and elsewhere, is how much has changed for the good despite the weak quality and performance of the government, and the public administration.   The ministries and the Central Bank have been slow and often indecisive.  There is no sign that they are improving.  Out in the provinces it has become seriously dysfunctional.

But this has always been a rough neighborhood.    Few other countries in Latin America are any better and some are much, much worse.   Brazil’s economy is falling this year as it will in 2016, in the midst of world-class corruption and mountainous mismanagement.   Sao Paulo, for instance, has run out of water. Venezuela and Argentina, two of the best-endowed countries in the world, continue to sink into incoherence, apparently endemic. This is a level of political stress from which Peru has notably escaped with no sign of a turn, much less return, to the serious confusion of the 70s, the 80s and the 90s.

The most consistent measure of the perversity of today’s financial markets is in the commodities.  These will continue to stay low and to sink.  This is not, exactly, because the world is in recession.  It is not even that demand for copper, oil, lead, zinc, tin  has fallen but that it is not rising to absorb what is coming every day onto the market.

New iron ore mines and oil and gas fields and techniques have opened, paid for with cheap money.  The problem is that even cheap money has a price, has to be paid for.  The iron ore companies, including Vale do Rio Doce, Anglo American and BHP, have between them issued $200,000mn worth of bonds to finance mines without a market.  China was supposed to buy it but is disappearing back into its Oriental mist.  A part of this is the heat-hazy nature of Chinese accounting where statistics, profits, loans and taxes are spelled differently in Chinese. The same happened in Japan as of a quarter of a century ago.

Copper is in the same slow boat.   In Peru, Toromocho (Chinese), Cerro Verde (Freeport M), and Las Bambas (Chinese), fine mines all, will be getting $2/lb instead of the $4-5/lb they expected just three years ago.  Chile, led by Codelco, the state-owned, high-cost mammoth, has it even worse which is why it, too, is being downgraded.

Morgan Stanley says that its downgrade warning on Peru will be confirmed on September. 30 but this is a formality.     It means that foreign funds will be selling their investments in companies like the Banco de Credito, Graña y Montero and Buenaventura quoted in Lima, and Peru-based companies quoted in New York and London.  Many funds will be selling, too, some of their holdings of bonds issued by companies in Peru.  The sums may be impressive.  Between 2010 and 2013 alone, US$15,000mn worth of bonds were sold to international investors, according to Bloomberg.   Peru is just a part of a bond bubble including China itself, as well as other members of the Troubled Ten.

Similar downgrades are being issued for other countries in Latin America and elsewhere.  The government-backed debt of Brazil, not long ago a Wall St. high flyer, has been knocked down to a notch over junk.

This is not the case for Peru, which has just raised $2,000mn on Wall St at only 2.5% more than the rate paid by the United States Treasury.  It is remarkable, looking back a couple or three decades, that loans of this size and price should have become routine, merely a note in the middle of the financial pages.   The money is needed, this time, to shore up the government deficit that has appeared because of the slowdown of the economy, and they will certainly need more to fill an even bigger tax shortfall in 2016.

Another sign of homebrewed discomfort is that inflation is running strongly higher than the Central Bank’s target of 2%:  it is probably higher than six percent.  This week Mr. Velarde, executive president of the Central Bank, cited inflation, which he has a constitutional mandate to control, and the exchange rate as among his “growing fears.”

Peru’s Central Bank, the BCRP, and even the lame-duck Humala government, may want to take comfort from being in the same lifeboat as bigger, noisier countries.  Peru is only three percent of the dollar investment to Latin America. Another way of looking at it is that Peru is being dragged down by the neighbors.

This is not going to persuade many Peruvians.  They will remember that the economists at the Central Bank, BCRP, and the Ministry of Finance, the MEF, were predicting as recently as this past Christmas that Peru would be growing this year at a tear-away 5.6%.

This made no sense (PT, Jan 22 and 29, 2015) but set the scene for inappropriate policies.  They should long ago have launched an emergency plan, with low Soles interest rates and a fast-track devaluation of the Sol, from S/.3=$1, as it was at the beginning of the year down to S/.4=$1, before the end of the year.   This was the path taken by well-managed central banks like those of Japan and the EU, Canada, Sweden and Mexico.   Instead, the Central Bank in Lima has moved the exchange rate only just a tad more than inflation, to just over S/.3.25, burning $1,000mn a month of dollars that are going to be needed 2016-2018. This is allowing bankers here and abroad to buy billions of dollars at a giveaway price.  This questionable policy is why Peru has been dumped, as Bloomberg has it, into the bucket of the Troubled Ten

Forget a recovery, even of the United States

There is no prospect that basic commodities prices will increase for  years.    Huge  iron ore mines in Brazil and Australia will be producing at a loss. Oil will be priced at thirty-something dollars a barrel.  Natural gas will be down to prices that only the huge fields in North America, Australia and the Middle East can do.

For Peru as for other third-level hydrocarbon areas, this means that the jungle oilfields and the Camisea gas fields are today, and maybe forever, worthless.  They are, in today’s terminology, “stranded assets”, on the books as potential profit centers but in practice valueless.

Peru has great resources and fine prospects, in agriculture, for instance, as well as mining.

But in today’s world, Peru is nowhere for oil and gas. As part of a Peru emergency plan to ride out the recession, the government should close down Petroperu and write off the jungle gas and oilfields.  Peru will be able to buy cheaper for years from Mexico, Canada and the United States.

Work on the Southern Peru Gas Pipeline should be halted immediately.  This  $8,000mn piece of corruption-ridden nonsense, being constructed by Odebrecht, Sao Paulo, whose chief executives are in jail for similar boondoggles at home, should be transferred  to the Brazilian taxpayer.

Any expectation that the Peru economy might stay afloat is made unlikely by predictions in Lima, the United States and elsewhere that a big El Niño is beginning. Based on the experience of 1972, 1983 and 1997-8, this will subtract between two and four percent from the country’s output.

The good news is that a capable new government may take control in less than a year’s time, ready and able to turn the progress of the past several years to good account.

A version of this article appears in Caretas No. 2399 under La Fiesta se Acabó. 

Nick Asheshov was editor of the Andean Air Mail & Peruvian Times during the 1970s and 1980s, and of The South Pacific Mail, Santiago during the 1990s.  He was Latin America Editor of Institutional Investor, New York over the same period.  He lives in Urubamba, where he has been prominent in the hotel and railway business.