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Peru | Lessons learned from Ecuador

| April 30, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

With Peru now following Ecuador into a polarizing second round of elections with a far-left candidate the frontrunner, it is tough to be optimistic. The stakes are not the same, of course. Ecuador is among the lowest and Peru the highest rated credits in the region, and Peru’s economy is much more resilient to political cycles.  But the latest polls are worrisome. The rhetoric of a far-left candidate suggests a shift towards radical policy risk. The relative year-to-date underperformance of Peru on credit spreads may continue, with potential for bearish curve steepening of the longer tenors.

There are a few important takeaways heading into the runoff round in Peru.  The polls are notoriously unreliable everywhere; however, that’s not typically the case in the second round when voter preferences narrow from 18 to two candidates through a lengthy campaign cycle running April 11 to June 6.  The voting intentions were particularly accurate in the final phase of Peru’s campaign in June 2016, well within the 3% margin of error.  The second-round polls showed a tight race even in the early phase of the runoff in April 2016 that continued into a narrow victory for PPK in June 2016.  The track record from the 2016 elections shows high frequency of polls with much lower variability and perhaps less political bias relative to Ecuador. The early polls this month show a clear divergence with a 10% to 20% frontrunner advantage for PL candidate Pedro Castillo.  There is yet no consecutive polls to assess a trend with the first week of May the first preview for follow-up polls.

This is not the same comparison to the upset victory in Ecuador where CREO candidate Lasso was able to reverse a 12% deficit on the first-round results to a 5% surplus thanks to a negative campaign that exploited the Correismo corruption and autocracy.  There is a lengthy second round of almost three months, and it would require a highly effective campaign to reverse the significant 10% to 20% advantage. The dark horse candidate Pedro Castillo does not carry the same political baggage of veteran politician Keiko Fujimori, weighed down by concerns about corruption.  The only prospects for a tighter race would be to level the playing field with either counter-allegations of corruption or scare tactics of radical economic policy management.  The latter is a less effective strategy in light of the populist backlash against a weak recession and the lowest vaccination rate among middle-sized comps in the region. The Castillo populist agenda is not necessarily a liability for the majority of the population suffering in the Covid aftermath.

The dominant themes of the Ecuador elections were less about pro-populism and more about anti-corruption. The Peru runoff round is equally binary on policy risk but with a higher rejection rate of the traditional moderate candidate for the stigma of corruption. The rejection rate for PL candidate Castillo is mostly for radical or communist views (Datum @ 58%) and not from guilt by association  with the widespread corruption throughout his party. The Ecuador voter tolerance for corruption was low after 12 years of Correismo and consecutive allegations and investigations.  The 10% to 20% margin seems almost unsurmountable, especially since a negative campaign may just increase “null” votes as opposed to transferring votes to Fujimori.  The prior runoff round simulations showed Fujimori losing to all of the candidates with high rejection rates reinforcing a low ceiling of voter support. It is also notable that the second-round support of 21% to 31% is far below the initial second round support of 39% to 43% for the last election cycle.

The advantage for Lasso was that he was able to coalesce and capitalize on the anti-Correismo corruption sentiment with direct and indirect endorsement from the majority of the political parties. The center-left-to-center-right political support shifted from 73%-to-27% to 59%-to-41% between the first and second round. Part of this crossover support was also a rejection of relapse into autocracy that would weaken the other political parties.  These comparisons do not hold for Peru.

The markets have already partly adjusted to the rising risk premiums; however, the impact has not been uniform. The flat Eurobond curve suggests some complacency on the longer tenors. The Peru Eurobond curve appears quite flat, trading closer to Panama than Colombia and Mexico with bias for curve steepening on higher election-related policy risks. Perhaps this initial resiliency reflects optimism of policy moderation after elections under either a Fujimori victory or Castillo moderate policy shift (Humala reference) or the checks-and-balances of a divided congress that forces policy moderation.

The lessons learned from Ecuador suggest caution on not only the election outcome that favors the anti-corruption candidate (Castillo) but also the policy risk of a radical candidate (similar to Arauz). The antagonist rhetoric sounds all too similar to extremist politicians in ‘B’ countries (Correismo and Kirchnerismo) with any centrist shift, politically motivated to attract votes pre-elections, and not credible for moderation post-elections.  The bottom line is that the strong Castillo advantage and the risk of policy extremism should continue to weigh on credit risk premiums. There is potential for bearish curve steepening with convergence to low investment grade credits like Colombia and Mexico. The checks and balances of a fragmented legislature and strong liquidity buffers may stymie radicalism; however, radical policy risk bias after elections suggest higher credit term premiums on the longer tenors.

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