BY WALTER T. MOLANO
S&P’s decision to upgrade Peru marked a brave moment for the credit rating industry. It’s not so much that Peru did not deserve an investment grade rating. Peru has some of the best macroeconomic indicators in Latin America. It was that the rating agencies were afraid of moving it into the vaunted position prior to the elections.
The high probability that Ollanta Humala, a close ally of Venezuelan President Hugo Chavez, will win the presidential elections in 2011 poses a risk that the next administration will radically undermine Peru’s macroeconomic policies. Hence, the rating agencies would lose creditability by having to downgrade it again. However, the decision to upgrade Peru may actually spark such a profound economic change that it will propel Peruvian society in a whole new political direction.
Peru has some of the most impressive macroeconomic indicators of the region. With an expected GDP growth rate of 7.3 percent y/y for 2008, Peru should have best performance among the large Latin American countries. Exports are surging, jumping 31 percent y/y in May. As a result, Peru should post a current account surplus of 2.6 percent of GDP this year. The trend will only improve over the course of the next few years as more export products come on line.
Energy Minister Juan Valdivia recently announced that Peru will become a net exporter of crude oil by 2010, thanks to the heavy investment in the oilfields that were recently discovered in the northern jungles. Peru has one of the lowest inflation rates in the region, thanks to a liberal labor regime.
Strong capital inflows, stellar export performance and prudent macroeconomic management are the main reasons why the country halved its debt to GDP ratio since the start of the decade. In reality, Peru deserved an investment grade rating as early as two years ago, when its debt ratio dropped to below 30 percent.
Unfortunately, Peru lacked the marketing muscle of Brazil and Colombia to woo the credit rating agencies and investment banking community. Given its huge pension fund system and favorable balance of payments, Peru was not a frequent visitor to the international capital markets. Therefore, there was not much of a reason for the finance ministry, neither the investment banking community nor institutional investors to lobby for a higher rating. President Alan Garcia understood the political value of gaining an investment grade rating, but he was more occupied with other tasks. Some analysts and investors thought it odd that Brazil was upgraded before Peru. However, with powerful sponsorship, it is difficult for the rating agencies to analyze credits on its own merit. That is why S&P’s decision to upgrade Peru is so notable. Perhaps it was moral compensation for the decision to upgrade Brazil, a country whose credit conditions are deteriorating, instead of Peru, a country whose credit quality continues to improve.
Yet, there are psychological effects produced by the investment grade rating that can have fundamental social, political and economic consequences. Countries with investment grade ratings, whether they deserved them or not, gain a higher level of confidence that generates more foreign and domestic investment. The risk premium demanded by multinationals and foreign investors is slashed after the upgrade. At the same time, the investment horizon is elongated. The same occurs with domestic investment. Local investors gain more self-confidence, thus allowing themselves to consider opportunities with lower rates of return. The impact is immediate, as consumers gain access to credit with more favorable terms.
The increased indebtedness leads to a social-political phenomenon that was recently exploited by the senior strategists of the Bush Administration. This concept was known as “ownership society” --whereby the more a society indebts itself in order to buy expensive homes and goods, the more they will embrace conservative values. Instead of preferring politicians who promise the seizure of private property, the abrogation of contracts and the redistribution of wealth, the newly indebted voters will gravitate towards conservative platforms. They will prefer politicians who promise pro-market policies that protect property rights, promote credit and attract foreign investment.
Therefore, the fear that the upgrade of Peru would have no effect on the country’s political environment could not be further from the mark. On the contrary, the new investment grade rating could spark the social-economic transformation of Peru into a conservative society that has no place for the likes of Bolivarian politicians, such as Ollanta Humala.
Walter Molano is head of research at BCP Securities.