DBRS Confirms Peru at BBB (low) on Strong Policy Framework

DBRS has today confirmed its ratings on the Republic of Peru’s (Peru) long-term foreign and local currency securities at BBB (low), and maintained Stable trends on both ratings.

“The Stable trends balance Peru’s strong policy framework and resilience to the crisis with an unpredictable political environment ahead of the presidential elections in 2011,” said Michael Heydt, DBRS Senior Financial Analyst, Sovereigns. “We believe that political risk has declined in recent years and that the next administration will likely preserve the current macroeconomic framework. However, we want to stress that policy continuity through the political cycle is crucial to the ratings.”

Peru’s aggressive fiscal and monetary policy response, in addition to its well-regulated financial sector, is cushioning the impact of the global downturn. The government introduced an ambitious $4.5 billion (3.6% of GDP) stimulus package, primarily financed by fiscal savings, to bolster domestic demand and develop the country’s infrastructure. The Central Bank (BCRP) injected $11.4 billion (9.3% of GDP) in liquidity to stabilize credit markets, and has cut interest rates 525 basis points since February to a record low of 1.25%. Furthermore, sound regulation and limited reliance on external funding protected the financial sector during the crisis. As a result, Peru is well positioned to resume solid economic growth as the global economy recovers in 2010.

The ratings are underpinned by Peru’s low public indebtedness and high international reserves. Due to prudent fiscal management and robust economic growth, gross public debt declined from 47.1% of GDP in 2003 to 26.5% in September 2009, among the lowest in Latin America. Debt reduction has been accompanied by a gradual shift from external to domestic financing. This has reduced exchange rate risk and facilitated the development of local capital markets. Moreover, with international reserves of $33 billion, the public sector is a large net external creditor.

To strengthen growth prospects, the government is promoting private sector participation in infrastructure projects, expanding efforts to improve the business climate, and proactively seeking free trade agreements (FTAs) with major trading partners in Asia and Europe. The China-Peru FTA was signed this year, and negotiations with Japan, South Korea and the European Union will continue in 2010. Furthermore, recent legislation has improved labour market flexibility, and measures by the BCRP have gradually reduced dollarization levels.

Nevertheless, the political implications of widespread poverty and regional inequality present the single greatest risk to Peru’s macroeconomic stability. While improving social indicators in recent years have reduced political uncertainty, DBRS believes that as long as the benefits of economic growth are not more widely shared, the risk remains that a populist politician could win the presidential elections in April 2011 and undermine Peru’s sound macroeconomic framework.

The Peruvian economy also faces several long-term structural challenges that could hinder growth potential. First, the quality of public expenditure is poor. The government, particularly at the sub-national level, often lacks the institutional capacity to allocate public resources in an effective manner. Second, the economy remains highly dependent on the mining and energy sectors, exposing exports to the commodity-price cycle. Third, dollarization across the economy creates currency mismatches and balance sheet vulnerabilities that carry exchange rate risk. Fourth, labour market rigidity hinders productivity and contributes to a large and inefficient informal economy.

Peru’s macroeconomic policy framework has provided a foundation for economic growth and social development. If the next administration is committed to policy continuity, then continued poverty reduction alongside improvements in the state’s institutional capacity to deliver goods and services could put upward pressure on the ratings. If the policy framework is not preserved, the ratings will come under downward pressure.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Sovereign Governments, which can be found on our website under Methodologies.

This is a Public Finance (Sovereigns) rating.