Prospects for doing trade finance in Peru are expanding. Long-known for having a strong mining industry, the country is now investing in infrastructure and financial services, writes Eleanor Wragg.
When investors look to the countries of Latin America, they tend to do so with some suspicion. With currency and investment disasters in Argentina and Venezuela, the likelihood of overheating in Brazil, and a potential political shift to the left across most of the region, trade and investment in Latin America is not for the faint-hearted.
Over the past few years, Chile has stood out as being not only very attractive, but safe for investors. However, its neighbour Peru is now emerging as the next one to watch.
With its rich endowment of minerals and other natural resources, an unparalleled location – sharing a border with Brazil, the largest market in South America and with access to the both the Pacific Ocean and the Atlantic through the Amazon River – Peru’s economy is one of the most dynamic in South America.
Nevertheless, the country still has some way to go. Lack of diversification and dependence on global commodity markets expose the country to high levels of volatility. And with presidential elections around the corner, it remains to be seen if this traditionally noisy democracy will continue to provide a stable investment location.
Over the past few years, the country has experienced unprecedented economic growth. A growing tax base combined with fiscal discipline and prudence resulted in surpluses, leading to the reduction of public debt from 45.5% of GDP in 2000 to 24% in 2008, and enabling the augmentation of the Fiscal Stabilisation Fund.
“The Inter-American Development Bank (IDB) is working closely with the Peruvian government to help it to combat poverty and inequality”
Peru was able to implement a significant fiscal stimulus of almost 3.5% of GDP in 2009, targeted to support micro and small enterprises, exporters, construction and social programs.
“In spite of an uncertain foreign context, so far this year the Peruvian economy has recorded an intense cyclical upturn. GDP growth peaked in 2Q10 (plus 10.2% year-on-year) and we expect it to remain high in the second half of the year, taking the overall 2010 growth to 8.5%,” says Juan Carlos Sanz, executive director of business development at BBVA.
“Fixed gross investment, in particular, is growing at a pace of over 25% year-on-year, something that is consistent with high business confidence and with both project renewal and undertaking in various sectors, especially in mining, infrastructure and manufacturing.”
Past turbulence
The country’s economic growth in the face of a global downturn is remarkable in itself, but even more so when it’s recent history is taken into account.
Just 20 years ago, the Peruvian economy was struggling through hyperinflation, serious distortions in the structure of relative prices, recession, unemployment and the reduction of workers’ real incomes, along with decreased tax revenues and a weakened state.
In the years following the return of civil rule in the country in 1980, Peru saw accelerating inflation, recurrent balance of payments crises and a progressive impoverishment of much of the population. General welfare levels were low, with social conflicts and armed violence all too common. The 2.775% inflation rate in 1989 was the highest in Peruvian history. The overvaluation of the national currency resulted in capital flight and hampered exports. This economic crisis in turn created social unrest and an upsurge in political violence.
In many areas of the country, the infant mortality rate and height-weight ratios – two basic social indicators – dropped to levels similar to those of African countries with much lower per capita incomes. Throughout Fujimori’s presidency, from 1990 to 2000, destabilising factors such as terrorism, border disputes and hyperinflation were brought under control. However, the former president led the country into constitutional crises, and his determination to hold on to power eroded democratic institutions.
Alan Garcia Perez, who governed as a leftist in the 1980s, upsetting the IMF by unilaterally declaring a limit on debt repayment and isolating Peru from the international finance markets, is now a somewhat reformed character.
His latest presidency, which commenced in 2006, has been characterised by a foreign trade and investment policy aimed at a process of deregulation and liberalisation of the trade regime. Combined with trade opening and a supportive international economic environment, the country has become an attractive investment and trade destination.
“In general terms, the economy has been very well managed,” says Carlos Suarez, senior analyst of banking risk at IHS Global Insight, “Macroeconomic policies have followed a very orthodox path and the Central Bank is taking the right measures in order to contain inflation and to try to curb the credit growth. The country has a strong regulatory framework in terms of capital markets and banking and that may attract a significant numbers of foreign banks and foreign financial companies within the next couple of years.”
“There are only two big industries that work with trade finance in Peru, mining and fishing/agriculture. Infrastructure is now becoming another industry that requires more trade finance”
The World Economic Forum (WEF) Global Enabling Trade Report 2010 ranks Peru 63rd out of 125 countries, an increase of two places from 2009. This score is boosted by Peru having one of the best PPP regulatory frameworks in the sample, extremely efficient license granting processes and land purchase regulations.
This is extremely encouraging, given that, according to WEF, the country “presents the second highest infrastructure gap in the region after Bolivia, with significant opportunities for private investment especially in road, air transport and electricity infrastructures. Peru has moderate levels of public debt (31.70% of GDP) and deficit (0.30% of GDP), low inflation (2.40%) and very stable exchange rates.”
Peru has also been ranked very closely to Chile in certain attractiveness dimensions including private investment in infrastructure and financial market enablers. It ranks first in the region for government readiness to deal with private investment for infrastructure, and performs particularly well compared to its peers in the region for its well developed equity and bond markets and sophisticated and diversified pension funds.
“In Chile, everything has been done in terms of where the country can grow. For investors and trading partners, Peru will become a better destination to invest and might become more attractive because it has bigger potential than Chile,” says Suarez.
However, in its inflation report, published in June 2010, the Central Reserve Bank of Peru (BRCP) warns that a faster than expected growth of private and public spending could create inflationary pressures, requiring interest rates to be increased in order to stabilise prices, which could lead to the crowding out of private investment. Nevertheless, there is little concern at present about the formation of bubbles:
“Peru’s financial sector is still one of the smallest ones in Latin America, therefore it is still difficult to think that it is reaching concerning growth levels or that it is creating bubbles like the ones in developed countries in the past years,” says Felipe Jaramillo, World Bank regional director for Bolivia, Chile, Ecuador, Peru and Venezuela.
Spreading the wealth
Unfortunately, as the country’s economy has grown, so has its inequality. This trend is especially evident in contrasting Peru’s coastal region with the Andes, with most of the increase in personal income being concentrated in Lima and other coastal urban areas. Peru’s National Statistics and Information Institute (INEI) recently reported that rural highlands were the least successful in reducing poverty during 2007.
Peru is taking successful steps to address this. According to the UN’s 2010 Regional Report on Human Development for Latin
America and the Caribbean, in 2009, 11.5% of Peruvians were living in extreme poverty, compared to 23% in 2002, a huge decrease.
The Inter-American Development Bank (IDB) is working closely with the Peruvian government to help it to combat poverty and inequality.
“The government recently passed a law to expand health insurance coverage. This is a signal that the government is taking on the traditionally low coverage and expenditure as a high priority to improve. There is also a conditional cash transfer programme, Juntos, which is an important area of work in social protection,” says Ian MacArthur, senior sector specialist at the IDB.
Peru has also signed a flurry of free trade agreements (FTA) with China, Japan, South Korea, Canada, the European Union and the USA. These FTAs will create an additional 40,000 jobs, evenly spread throughout the country, which will help to decrease inequality.
“We are already seeing an increase in the trade flow between Peru and China, especially on the mining export side. Peru is a big supplier of copper, zinc and lead. Big mining companies in Peru are establishing facilities in China to try to improve this flow,” says Antonio Alves, senior regional head of trade finance in the Latin America and Caribbean Region at the IFC.
“To fully benefit from its geographical location and array of free trade agreements, Peru urgently needs to improve its infrastructure. There is a huge infrastructure deficit equivalent to 30% of GDP, including ports and highways in order to channel exports to Asia,” adds Sanz.
“Fixed gross investment, in particular, is growing at a pace of over 25% year-on-year”
Peru’s total trade export volume in 2008 was US$31.49bn, according to the IMF’s directory of trade, increasing by over 80% from 2005 and outperforming the APEC bloc as a whole, which experienced a total export volume increase of 50% over the same period.
To further build on this growth, the IFC expanded its global trade finance programme (a scheme that provides guarantees on trade debt obligations) into Peru 16 months ago, and has so far incorporated two Peruvian issuing banks, BBVA Continental and Banco Interamericano de Finanzas.
“Today, the most popular economies in the region to invest in are Brazil and Peru,” says Alves, “The IFC has 10 issuing banks in Brazil, whereas in Peru there are only two. This is mainly due to the number of industries that are active in the trade finance sector. There are only two big industries that work with trade finance in Peru, mining and fishing/agriculture. Infrastructure is now becoming another industry that requires more trade finance on the import side.”
Financial sector growth
The infrastructure sector is not the only one to offer opportunities to investors. The financial system has rapidly developed over the past few years, which is evidenced by the entrance of new participants and mergers, giving rise to the geographical expansion of the microfinance system.
The strengths shown by the microfinance system have led Peru to rank first in the Economist Intelligence Unit’s 2010 report on microfinance. In 2009, the Peruvian microfinance market continued to progress, showing a 14% increase in the number of borrowers from 2008.
The gross credit portfolio grew from US$4.08bn in 2008 to US$5.47bn in 2009, an increase of 34.2%.
“Given that a large part of the Peruvian population do not currently use the financial system, opportunities are significant in the micro-lending sector as long as there is a good understanding of the market and an adequate risk management,” says Sanz.
In Peru, small and micro enterprises account for 95% of all business in the country’s manufacturing, commercial and service sectors. Such enterprises also employ 65% of Peru’s urban workforce.
In short, Peru is rapidly developing in all the right directions, and is open and ready for trade and investment in many growing sectors. It also appears to be a relatively low risk destination.
Risks
In the short term, Peru’s political risk is considered by the Belgian Export Credit Agency (ONDD) to be in the lowest category, a position it shares in South America with French Guiana, Chile and Colombia. In the medium term, the political risk moves to third position out of a possible score between one and seven, a position it shares with Brazil.
Concerns remain about the potential election in April 2010 of an anti-system candidate, which could lead to fundamental changes in Peru’s economic model.
“Despite the fact that it has been a very stable country for the last six to eight years, the risk is always the political and social unrest. If a candidate is elected who is more in line with the ideology from other countries, especially Venezuela, the country will face serious difficulties,” says Suarez.
However, it seems very unlikely that such a scenario will materialise.
“Concerns over the elections outcome are mild, a situation that markedly contrasts with the previous election in 2006. It would be unlikely to see major negative impacts on the economy as a whole: private investment should continue growing at high rates,” says Sanz.
Moody’s upgraded Peru’s rating to investment grade last December. According to their Peru Credit Report, the reassessment of susceptibility to event risk was an important factor behind their decision to upgrade Peru. Improving economic and social indicators, including a sharp drop in poverty rates, have increased the number of Peruvians with a personal stake in preserving a model that has been able to provide increased economic opportunities in a context of continued macroeconomic stability. Developments in Venezuela have made Peruvians increasingly aware of the not-so-attractive consequences of an alternative economic model.
The electorate’s behaviour during the last presidential election also showed that, when confronted with a clear choice between pro- and anti-system candidates – Alan Garcia or Ollanta Humala – Peruvians opted for the conservative, pro-system option.
Sources within the country see the political risk generated by the upcoming elections as small. “I have the impression that with the election of any of the candidates who currently lead the polls, including Fujimori, Toledo and Castañeda, the same social, macroeconomic, trade and finance policies will be maintained as we have seen in the previous governments of Toledo and Garcia,” says one political analyst.
“The great advantage of Peru is the economic and political stability. We do need to take the upcoming presidential election into consideration, but Peru is going to become much more important on the trade finance market. There is a limit in terms of room to grow, because of the size of the country, and the growth in absolute terms will not be the same as that of larger economies, but proportionally speaking, Peru is becoming and will become in the years to come a major player on the trade finance market,” says Alves.
Therefore, Peru – a country well known in the mining sector as a significant producer of copper, zinc, gold and transition metals – is now emerging as an attractive investment venue and trading partner in other sectors, particularly infrastructure and financial services. Any successor government will almost certainly pursue a relatively conservative, centrist course, which suggests that Peru should be looked at seriously by emerging market investors with medium risk appetites. GTR
