Everyone’s A Winner – Except Peru

Conclusion: We maintain our view that the current Peruvian election will serve as a catalyst for incremental economic liberalization throughout the region over the long-term TAIL. Furthermore, the potential for Peru to succumb to socialist rule is likely to be supportive of higher silver, gold, and copper prices over the long term.


Last week, in a report we published titled, “Peruvian Crystal Ball”, we detailed how the current Peruvian election would serve as a catalyst for incremental economic liberalization throughout the region. The key claim supporting this thesis was that severe weakness in Peruvian financial markets would serve as a warning sign to the region’s leaders to avoid implementing socialist reforms:


“[The] sell-offs [in Peruvian assets] have the potential to destabilize the Peruvian economy and should be viewed as a warning sign to politicians throughout the region. Gone are the days of simply parlaying the poor vote into election victories – particularly at the highest office. As we are seeing currently, Latin American politicians must pay increasing attention to the desires of international investors, as well as the needs of the region’s growing middle class…we expect this trend to continue.”

-Peruvian Crystal Ball, April 19, 2011


Such potentially destabilizing “warning signs” have been loud and clear. In the last two months alone, Peru’s currency has lost (-1.9%) of its value (vs. USD). That’s tops among all currencies globally vs. the greenback and is only bested by the US Dollar Index’s own (-5.1%) decline. If you didn’t know, now you know – socialism is bad for a currency. Peru’s equity market (Lima General Index) tells a similar tale, plunging (-19.2%) over the last month – the largest decline for any equity index in the world over that duration.


Everyone’s A Winner – Except Peru - 1


The international flight out of Peruvian assets is being driven by the potential for the country to succumb to socialist rule in its June 5 run-off election. An Ipsos Apoyo poll released Monday showed the left-leaning Ollanta Humala had a six percentage point lead vs. his right-leaning opposition candidate, Keiko Fujimori (42% vs. 36%). A deeper look into the poll results show that Humala’s chances of victory are perhaps even stronger than the 600bps delta would indicate: 

  • Humala is rallying his target constituency – the Peruvian lower class – better than Fujimori is rallying her target constituency – the Peruvian middle-to-upper class: Humala garnered 44% of the vote outside of metropolitan Lima vs. Fujimori’s 33%; within Lima, Fujimori won over its middle-to-upper class voter base (as expected), but by a narrower margin (43% vs. 35%). Further, Lima represents only about 1/3rd of Peru’s aggregate voter base, meaning Humala has the majority of voters leaning in his direction;
  • 35% of all respondents said they would never vote for Humala vs. 38% for Fujimori;
  • Among the key issues holding these voters back, nearly 50% of all respondents believe Venezuela’s Hugo Chavez is financing Humala’s campaign vs. 68% who believe that Fujimori would pardon her jailed father, former Peruvian president Alberto Fujimori, who is currently serving a 25-year sentence for directing a paramilitary death squad; and
  • Nearly 2/3rds of respondents  said they are in favor of Humala’s proposal to change or replace the 1993 constitution introduced after then-president Alberto Fujimori dissolved congress and Peru’s courts in 1992. 

Net-net, it looks like Humala definitely has the momentum to succeed in this election. In our opinion, this is a major incremental change on the margin, given that there was the possibility that Fujimori could make a strong push in the polls if she does a good enough job scaring the Peruvian electorate away from Humala’s proposed socialist reforms. While there is still time for her to accomplish this mission, the net result of this poll suggests that accomplishing that task is less feasible than we anticipated.


The decreasing likelihood of a Fujimori victory points to a major shift in the mood of the Peruvian electorate towards wanting less of the same – particularly at the lower-income end of the spectrum. After having voted in incumbent Alex Garcia as “the lesser of two evils” relative to Humala in 2006, Peru’s lower class has grown increasingly fed up from the lack of wealth distribution created by the last 15-20 years of economic liberalization and robust GDP growth.


While Peru’s Real GDP has averaged +4.9% YoY per quarter since 1Q95 and its GDP per Capita has grown at a CAGR of +2.8% since 1995, its GINI Coefficient, a measure of income distribution, has risen +3.09 points over the same duration. This means that as Peru’s economy has grown throughout this recent era of economic liberalization, inequality from an income perspective has also increased. In Peru, the rich have gotten richer from an influx of international investment capital while the poor continue to watch the country prosper from an outsider’s perspective. As to be expected, this widening wealth gap has created a shift towards socialism on the margin in the political leanings of Peru’s aggregate voter base.


Everyone’s A Winner – Except Peru - 2


This sentiment was echoed to us by a very interested Peruvian national who we recently held a call with. Regarding the shift, he simply states, “People have grown impatient”, while also calling Peru a “glass ceiling economy”. Further, his words regarding the pending direction of the economy were very sobering indeed, saying flat-out, “I’m terribly sad; we we’re really making strides on a relative basis throughout the region… [a Humala victory] will set us back”. Additionally, his intel has led him to believe a Humala victory was perhaps more locked up than the market is currently pricing in, saying that 5 million-plus soldiers, their families, and friends are likely to vote for Humala after years of mistreatment by the central government (that’s roughly 16-17% of the population). Their opinions are not currently expressed in the aforementioned poll results, meaning that Humala might already be at or beyond the 50% needed to secure victory in the runoff election on June 5.


All told, it’s increasingly likely that Peru will succumb to socialist rule in the coming months. That has negative implications for the economy, given that an anticipated $50B in foreign mining, energy, and infrastructure investment stands to go the way of the dodo bird as Humala increases taxes and renegotiates existing contracts in an effort to increase the Peruvian government’s control of these industries. As a result, Peru’s economy is likely to suffer due to a lack of investment and higher taxes. Not to mention, the spectre of structurally elevated inflation remains a TAIL risk, given that much of the currency’s gains are, in fact, driven by foreign investment flows that are now in question.


While it’s clear that Peru stands to be the ultimate loser in this transition to a red regime, we do maintain our view that the economically liberal countries of the region at large will benefit from an increased propensity to lean to the political right, particularly when it comes to investment. If anything, Peru’s financial markets are a leading indicator for a potential long-term decline in Peru’s economic output and we’d be remiss to assume the region’s leaders aren’t taking notice. A Dilma Rousseff-led Brazil is one example where the potential for increased investor-friendly economic policies stand to benefit the country long term.


Shifting gears, the potential lack of investment Peru’s mining industry has two major implications going forward: supply in the silver, gold, and copper markets is likely to be structurally lower than current estimates suggest, as Peru is currently the #1, #6, and #2 producers of the metals, respectively. That’s a bullish data point for each of these commodities – particularly silver from a long-term headline risk perspective. Also, the investment capital that is currently projected to flow to Peru is likely to be redirected to places like Chile and Colombia, on the margin. The race to claim what was once Peru’s future economic prosperity just might officially begin June 5.


Darius Dale


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