Why Peru’s Democracy is at Stake in Vizcarra’s Anti-Corruption Crusade

As yet another corruption scandal reverberates through Peru, polling shows that citizens are disappointed with their government and doubting democracy itself. If new president Martín Vizcarra fails to lead Peru past the wrongdoing that has plagued its government for decades, Peru could fall into a democratic crisis.

On Saturday, Peruvian president Martín Vizcarra called for a national referendum on judicial and political reforms aimed at tackling the country’s widespread corruption. The week previous, he asked congress to debate the ouster of the country’s magistrates “in light of the evident acts of corruption and crimes”. These extraordinary moves come after recordings were released that chronicle widespread influence peddling between dozens of senior judicial officials and organized crime gangs. The judicial branch is only the latest Peruvian democratic institution to face a corruption crisis, after President Vizcarra himself assumed the presidency after the resignation of his predecessor due to corruption allegations. In fact, all six living Peruvian presidents have either been imprisoned, implicated, or investigated for corruption.

Governmental wrongdoing has undermined Peruvian belief in democracy

Polling shows that Peruvians are weary of these scandals, and that they have negatively affected their opinion of democracy itself. Surveys conducted in May, before the most recent round of corruption scandals, indicate that 62% of Peruvians are worried about financial and political corruption in their country, compared to 35% worldwide. This is enough to make Peruvians the most concerned among the 28 major countries surveyed. Confidence in democracy has followed a similarly troubling trend, with only 45% of Peruvians indicating that they support it, the lowest approval level in a decade. Upcoming polls will likely find that the situation has worsened, as anti-corruption protest marches have begun and there are movements to fly the Peruvian flag at half-mast during its Independence Day celebrations.

Vizcarra’s anti-corruption crusade

When he assumed office in March, president Vizcarra pledged to curb corruption “at all costs”. While this commitment may cause déjà vu among corruption-weary Peruvians, Vizcarra is one of very few Peruvian leaders that has any chance of bringing it to fruition. Most political decision makers that have the ability to reform the system have themselves been embroiled in corruption scandals. Key stakeholders in the public and private sectors have benefitted greatly from the status quo, and thus have little incentive to right the ship. Though Vizcarra faces substantial headwinds in his quest to clean Peru’s political system, there are three key indicators to watch that would suggest his attempts will be successful:

Firstly, if he pays close attention to the governmental structures that will enable his success. A clean, independent judiciary is a vital pillar of any successful anti-corruption campaign, so he should continue to enact drastic actions to clean out any wrongdoers.Firing wrongdoers and leading thorough reviews is a good start, but he should also be sure to identify and place an untainted crop of new magistrates lest a new judiciary display the same problems as the old.

Secondly, if he heavily leverages the Peruvian people’s dissatisfaction with corruption. It is clear that many politicians have an incentive to inhibit the success of his initiative, so Vizcarra must mobilize the citizens that they supposedly represent and pressure the politicians to either clean up their act or resign. Though Vizcarra’s approval rating has fallen precipitously to 37 percent from his initial figure of 57 percent, he still is far more popular than any other Peruvian politician. By calling a referendum, he has taken am first step toward uniting the Peruvian people behind him.

Thirdly, if he creates a functional relationship with the powerful politician Keiko Fujimori. While Vizcarra’s lack of political history and party affiliation makes him feasible as an anti-corruption crusader, it puts him in a weak position compared to Fujimori, who helms Fuerza Popular and controls a healthy congressional majority. Since the Peruvian constitution grants disproportionate power to the unicameral legislature, any major proposition by the Vizcarra government will require the de facto sanction of Fujimori. Fujimori herself is under investigation for corruption and money laundering and wasmentioned as a potential co-conspirator in the same recordings that revealed wrongdoing in the judiciary, so conflict between her and Vizcarra’s anti-corruption crusade may be inevitable. Nonetheless, if he is to expect any major success in his administration’s objectives he must find a way to at least maintain a temporary alliance.

Outlook: what if he fails?

Vizcarra is faced with the unenviable task of confronting corruption and reinvigorating the legitimacy of his government in the eyes of the Peruvian people. He will likely find that much of the Peruvian government is hostile to his cause. Since he is one of a very small group of Peruvian politicians that has a realistic chance of reforming the system, his failure could prove the final straw for citizens. Peru’s democracy is already lacking strong institutions and leadership, and the further exasperation and disenfranchisement of its citizenry would make it susceptible to power grabs. The end result of Vizcarra’s failure could be a state where establishment and anti-establishment strongmen compete for power.

 

Arthur Williams is a Consultant in the Kuala Lumpur office of Kaiser Associates, a management consulting firm.

No More Border Wall: Ecuador to Mend Relations With Peru

Suspension of the Ecuador-Peru border wall

On July 14th, Ecuador’s Foreign Minister Maria Fernanda Espinosa announced that the country had decided to halt the construction of the border wall with Peru (EPU). The wall was built as a flood precaution by Ecuador. It has been the center of controversy for some time now, straining diplomatic relations between the two countries. The issue had gained prominence following US President Donald Trump’s pledge to build a wall between the US (SPY) (IWM) and Mexico (EEW).

Peru, which believes that the wall infringed on a 1998 deal which prohibits construction within 10 meters of the border, recently recalled its ambassador from the country to express its rage over the decision. Subsequently, the foreign ministry of Ecuador announced the suspension of the construction of the mile-long, 13-foot high wall between the two Latin American (ILF) (GML) countries.

Ecuador mending relations with Peru

The suspension should bode well for Andean (AND) countries. The wall would have led to about 5,000 job losses on each side of the wall, primarily in the local fish trade. Currently, fishermen cart their fresh catches over the canal which outlines the border across bamboo footbridges. With the wall in place, workers would have had to take a lengthy detour to unload their catches in Peru probably putting an end to the trade.

Moreover, Peru counts among the top 3 export destinations of Ecuador. Close to $1 billion worth of goods are exported from Ecuador to Peru, accounting for 5.1% of its exports (see chart above). The wall would have certainly impacted cross-border trade volumes.

Now, while on one hand, Ecuador has taken a step to mend its diplomatic relations with Peru, on the other hand, it stands a chance to strain its relations with the OPEC (Organization of the Petroleum Exporting Countries). The next part of this explains how.

After Weathering the Storm Earlier This Year, What Will Drive Peru’s Stock Market?

In the first article of this series, we explored the stocks which have been holding back the broader stock market and exchange-traded funds investing in Peru. Meanwhile, the second article details issues facing the country and how it’s dealing with them.

So what do these components combined say about the outlook for Peruvian equities?

Short-term pain

Continued short-term pain for stocks from the country is likely, primarily due to reduced overseas investment in light of the ongoing investigations in the Odebrecht scandal involving previous administrations of the nation.

Meanwhile, investors would also like to see tangible signs of implementation of the government’s plan for rebuilding the country after being hit by severe floods earlier this year.

Another aspect which could hurt investment at least in the short-term is the political challenge faced by the country.

The government led by President Pedro Pablo Kuczynski is not yet a year old but has already seen three ministers – Jaime Saavedra (Education), Martin Vizcarra (Transport), and Alfredo Thorne (Finance) – being sacked by the congress. A similar fate probably awaits the Interior Minister Carlos Basombrío.

Thorne is the latest casualty in the $530 million Chinchero International Airport project contract matter which was also responsible for Vizcarra’s ouster. Kuczynski has named Prime Minister Fernando Zavala as Thorne’s replacement.

Political investigations such as this will continue to keep investors at bay for the short-term.

An economy with potential

Though the country is struggling to grow at present, it is considered to be among the most robust in Latin America.

Apart from the efforts the government is making to get the economy back on track and tackle the corruption scandal, it has another component which can help it bounce back — monetary policy.

The central bank reduced rates in May for the first time in over two years by 25 basis points, but held on to the 4% level at the meeting in June. Central bank President Julio Velarde has said that the institution will wait for the “right moment” to further reduce rates, preferably once credit demand is rising.

Outlook on equities

The table above lists the price-to-earnings (P/E) ratios of the ETFs tracking the five major emerging market economies of Latin America. While Brazil (EWZ) is the cheapest, Mexico (EWW) is the most expensive. Peru (EPU) is in the middle, between Chile (ECH) and Colombia (ICOL).

Peruvian equities may continue witnessing some headwinds in the short-term. Moderate risk-taking investors might want to wait for these headwinds to pass before initiating or adding to their stock holdings from the country.

However, more adventurous investors would find current valuations quite attractive and may initiate small buying positions. Those investors not taking the fund route need to steer clear of all firms which have connections to the Odebrecht scandal though.

Peru Is Hoping To Turn Challenges Faced By Floods Into A Rebuilding Opportunity

Macro factors have had a major bearing on the stock market in Peru this year. Monthly economic growth in the country fell to near an eight-year low of 0.17% in April from a year ago as construction and manufacturing activity plummeted.

The country’s central bank also reduced the growth forecast for 2017 to 2.8% in June from 3.5% projected in March.

Floods in the first quarter of this year were the main reason for the sharp decline in economic activity, particularly in construction.

The country’s Ministry of Economy and Finance has held that the floods damaged infrastructure worth about $4 billion and has estimated that it may have shaved close to 0.5% of economic growth off the first quarter of this year with construction having nose-dived by 5.3% in the same period.

The other challenge is the corruption scandal.

The Odebrecht scandal

Brazil’s construction giant Odebrecht’s $800 million corruption scandal has engulfed countries across Latin America. Of the total sum, the company has admitted to paying $29 million in bribes to three Peruvian governments under presidents Alejandro Toledo, Alan Garcia, and Ollanta Humala.

Due to this, the country has witnessed a drop in investment confidence, which has resulted in an overall decline in investment. Current President Pedro Pablo Kuczynski has promised a clean-up, but it will take time for investors to regain confidence.

An opportunity?

As far as the damage from floods is concerned, President Kuczynski has said that reconstruction and new infrastructure will cost $9 billion over the next five years. This will undoubtedly push the country’s fiscal deficit up. Central Bank President Julio Velarde stated that the institution expects a higher fiscal deficit of 3% of GDP in 2017 and 3.5% in 2018.

However, the spending plan will be helpful in raising the country’s economic output. Though the impact was severe enough to slow down economic growth this year, the central bank expects GDP to grow by 4.2% in 2018 – a tad higher than previously estimated.

The challenge posted by the corruption scandal is a common thread across the region, hence it’s not a challenge for Peru alone. The government’s response so far has been swift, and given the robustness of the economy, the country stands a better chance of seeing investors return earlier than most of its Latin American peers. But this will also depend on the future course of action taken by the administration.

What do these and other developments mean for Peruvian equities going forward? Let’s look at this in the next article.

These Are The 5 Equities Holding The Peruvian Stock Market Back In 2017

Peruvian equities have been facing a number of headwinds in 2017. After a strong start to the year which saw the iShares MSCI All Peru Capped ETF (EPU) climb 11% by early February, the ETF has lost a lot of ground and is up only 4.4% for the year to June 22.

This performance places it better than only Brazil among the five countries included in the MSCI Emerging Markets Latin America Index.

The iShares MSCI Brazil Capped ETF (EWZ) is nearly flat for the year. Its performance has driven down the entire EM Latin America Index as it forms a mammoth 55.5% of the exposure of the Index. Meanwhile, Peru forms only 2.9% – the smallest allocation of the five countries.

The EPU is neck-and neck with the Global X MSCI Colombia ETF (GXG) and far behind the iShares MSCI Chile Capped ETF (ECH) and the iShares MSCI Mexico Capped ETF (EWW).

The stocks which have hurt the EPU

Industrials is the sector which has hurt the fund the most so far in 2017. Of the two holdings from the sector, engineering and construction major Graña y Montero S.A.A. (GRAM) has been the biggest negative contributor to the fund. In terms of total returns, the stock has plummeted 54.7% in YTD 2017 (in Peruvian Sol terms). However, since it forms only approximately 2% of the fund, the impact has been somewhat contained.

The second biggest negative contributor comes from the consumer staples sector. Multi-format retailer InRetail Perú Corp is one of the three holdings from the sector in the EPU and forms 3.1% of the fund. The stock is down 8.8% on the year, and has dragged down the positive contribution by the top holding from the sector – Alicorp S.A.A.

The third worst performer in 2017 so far comes from the materials sector. FOSSAL S.A.A. is a spin-off from cement-maker Cementos Pacasmayo S.A.A. (CPAC). The stock is no longer part of EPU’s portfolio, but its poor performance this year still makes it the third largest negative contributor to the fund.

The next two poorest performing stocks come from the utilities sector. Utilities follow industrials as the second worst performing sector with both holdings – Luz del Sur S.A.A. and Enel Distribución Perú S.A.A. in that order – dragging on the fund.

Let’s look at the headwinds which have held Peruvian equities back on a broader level in the next article.