In mid October, at the Annual Meetings of the World Bank and IMF, the Minister of Finance of Peru, Luis Valdivieso, announced his intention to float a US$600 million, 30 -year bond . Will currently dysfunctional capital markets welcome a new bond from a developing country issuer? The short answer is no , but Peru may be one of the exceptions .The paradox is that Peru could succeed to tap capital markets precisely because it does not need the money .It has been running budget surpluses for many years and its public debt is small .In fact , Peru is one of the few countries where central bank’s international reserves ( at US$35 billion or 26% of GDP ) exceed the total domestic and external public debt ( at US$ 30 billion ) . In other words , Peru’s public sector is a net creditor .Since the proceeds of the bond are not needed to pay for expenditures , the authorities intend to use the money to buy back Peru’s short-end maturity bonds from investors .The operation will extend the average maturity of the external debt , now at eleven years .
The international meltdown of the last two months has underscored the strength of Peru’s finances. Unlike in some other Latin American economies, the exchange rate of the sol – Peru’s home currency – has stayed stable with moderate central bank intervention and the inter-bank rate has not blinked much. Further, the authorities have not had to jump to the rescue of any big financial institution or corporate. It was most unfortunate that these achievements were clouded by a corruption scandal that prompted a partial renewal of the ministerial cabinet.
Beyond sound fiscal and monetary fundamentals, Peru have a relatively small but strong banking system –with total assets at just over one third of GDP .Banks are properly capitalized, well supervised, and extremely liquid. About half of total deposits are invested in either reserve requirements or official debt. The Central Bank is well positioned to pump sufficient sol and dollar liquidity by loosening requirements or buying back official paper. The structure of the banking sector also helps. Four large banks account for three quarters of total intermediation; and two of them belong to international banks, BBVA of Spain and Scotiabank of Canada, so far survivors of the recent purge. Peruvian banks operate with low leverage ratios (lower than ten to one) and practice traditional banking: loans for collateral.
A run on bank deposits is unthinkable for it would be unsuccessful .The reason is that the total deposit base of the system (about US$29 billion) is lower than central bank’s international reserves. Likewise the authorities have the latitude to nip in the bud any speculative attack against the sol.
It is clear that in the wake of the coming international recession, Peru’s GDP growth will slow down from 10% expected for 2008 and 7% average over the last six years .Declining export revenues and capital inflows will no doubt take a toll on incomes, tax revenues, and the balance of payments. However, analysts project Peru’s growth for both 2009 and 2010 at over 5 % .There are three key drivers underpinning this projection. The first is the strong pipeline of committed FDI projects under execution which total US$ 8 billion per year .The second is the scope the authorities have for contercyclical fiscal policy stemming from the strong budget and debt fundamentals. And the third is the feasibility of continued lending for local investment and housing in view of the sound condition of the banking system.
Peru is a real success story of free markets and fiscal discipline. Free trade has delivered a nine- fold increase in exports in les than two decades . Following progressive unilateral tariff reduction under the WTO, Peru recently signed a free trade agreement with the US and is now negotiating agreements with the European Union and China. Also, Peru is a textbook case of successful turnaround. Only eighteen years ago it was a basket case in default with all its creditors -including the IMF and the World Bank – and enduring hyperinflation .Today, Peru is a fast growing economy and its public sector in a net creditor. In recognition, in early 2008 the rating agencies S&P and Fitch lifted Peru to the selective club of investment grade economies.
Peru‘s central bank deserves a lot of credit in the country’s success. It is an independent institution, staffed with competent economists who view central banking as a lifelong job. The build up of international reserves to a level equivalent to one quarter of GDP is nowhere easy but it is all the more difficult in a developing country loaded with a backlog of social demands .This reserve buffer is paying off in these rainy days. In essence, Peru has underwritten its own insurance policy.
And what about poverty? The end result of Peru’s free market policies has been a steady reduction in poverty. From 2003 to 2007, the poverty rate –as defined by the World Bank – declined from 52% to 39% and extreme poverty eased from 21% to 14%. In the first two years of his second tenure, President Alan Garcia has shown strong commitment to poverty reduction under sustainable macroeconomic policies .This is in sharp contrast with his first term, from 1985 to 1990, when he tried to fight poverty under the wrong macroeconomic policies .The leadership and charisma of President Garcia is now at the root of Peru’s so far successful journey amid the unprecedented financial storm.
If the do not need the money, why then are the authorities determined to float a bond in today’s dysfunctional markets? One reason may be to signal to the capital markets its own macroeconomic strengths at a time when everyone’s vulnerabilities have been brought to an extreme stress test. Also, the success in placing the bond with investors will prove the point that sound economies are able to tap private capital -even in dislocated markets – as opposed to relying exclusively on “emergency room” financing from the IMF and World Bank.
Meanwhile, as few skeptic, beaten- down bankers shrug at the chances of Peru’s bond, investment bankers rush to Lima to present their bids.