By Jason Mitchell
The Banker Thursday, September 24, 2009
While the Western world has been struggling through the global financial crisis, Latin America has shown a remarkable resilience to the upheaval. Two countries in particular – Colombia and Peru – are showing particularly impressive growth, and look set to become important emerging economies.
With the prudent macroeconomic policies pursued in Colombia and Peru over the past five years starting to bear fruit, the two countries are set to become much more important emerging markets in Latin America over the course of the next decade.
One of the most important aspects of the international financial tsunami that has battered the world for the past year has been Latin America’s ability to act as a shock absorber, rather than as a shock amplifier as has been the case in previous financial crises. Brazil and Chile are probably the best examples of Latam economies that have weathered the storm well; however, Peru and Colombia have also shown remarkable resilience, especially given the countries’ turbulent economic histories.
Even countries such as Venezuela and Argentina – which have followed much more heterodox macroeconomic policies – have not suffered from a meltdown, although they are now suffering from stagflation (Colombia and Peru have only seen declines in gross domestic product [GDP]).
“One of the most notable things about Colombia and Peru is that they have not taken the hit from the financial crisis that many people expected,” says Joydeep Mukherji, head of the sovereign ratings group at Standard & Poor’s. “They have remained fundamentally strong. Furthermore, there are only a few countries in Latin America that have been able to run proper countercyclical fiscal policies during this crisis: Chile, Brazil, Peru and, to a lesser extent, Colombia.”
Colombia and Peru were among the region’s fastest growing emerging markets between 2003 and last year, expanding at an average of 5.4% and 7% a year, respectively. The economic expansion in both countries was fuelled by rocketing international demand for commodities – mostly oil, coal and gold in Colombia’s case, and copper, gold and zinc in Peru. Although Venezuela and Argentina grew at faster rates (averaging 10.4% and 8.4% a year respectively), Colombia and Peru did not experience the kind of inflation witnessed in those two countries. Goldman Sachs forecasts economic growth for Peru of 2% this year with inflation at 1.6%, and an economic decline in Colombia of -0.1% with inflation of 3.9%. Venezuela is forecast to have economic growth of 1% combined with inflation of 24.7%, while Argentina is expected to decline by -0.9%, with local analysts estimating inflation of 15% to 20%. According to the IMF, Peru’s GDP was $128bn last year (with a total population of 28 million people), while Colombia’s stood at $240bn (with 44.7 million inhabitants). The two countries have much smaller economies than Brazil and Mexico (at $1570bn and $1080bn, respectively), but are middle-ranking in size, comparable with Argentina and Chile (at $326bn and $169bn, respectively). “Colombia is a market economy, open to the international trade of goods, services and capital,” says José Dario Uribe, president of Banco de la República, Colombia’s central bank. “Property rights are respected and the rules of play are clear and stable. There exist guarantees for foreign and national investors. “Macroeconomic stability is valued and an independent central bank is in charge of monetary policy, maintaining low and stable inflation and a sustainable exchange rate regime.” Dr Julio Velarde, president of Peru’s central bank, says: “I am sure Peru will become one of the most important emerging markets in Latin America and have a modern economy within the next few years. “During the past five years the role of the free market has been pushed heavily in the country. Companies that were privatised were privatised well. State intervention has become a lot lower and tariffs have been reduced close to zero.” Fundamentals in place During the past five years, Colombia and Peru have become much more attractive destinations for foreign direct investment (FDI) and for portfolio investment; have seen their private pension fund industries expand massively in size; witnessed the development of private equity markets; seen the evolution of long-term yield curves; and experienced the rise of an acquisitive middle class.
Colombia has free-trade agreements with Chile, El Salvador, Venezuela and Mexico (the one with the US is quagmired in the US Congress), while Peru has agreements with Chile, China, the US and Thailand.
“Colombia and Peru have performed very well in terms of macroeconomic policy-making,” says Jerome Booth, head of research at private equity group Ashmore Investment Management. “They are both very close to Brazil in that sense. Both countries are now better credits than Argentina, and in fact are snapping at the heels of Mexico.”
Last year, one of Peru’s biggest achievements – and Brazil’s – was to secure investment grade from Fitch and Standard & Poor’s (Chile and Mexico have had the coveted status for a long time). Those agencies rate Colombia investment grade on local currency but not yet on the sovereign’s foreign currency ratings. Moody’s ranks Colombia and Peru (and Brazil) one notch below investment grade.
Two of the main reasons why the agencies rank Peru better than Colombia are the level of public debt against GDP and the fiscal accounts. In Peru, public debt against GDP was 27% last year against 40% in Colombia. Peru has strong fiscal constraints enshrined in law, while Colombia has had problems trying to ease the flow of central government transfers to the provinces.
Goldman Sachs forecasts an overall public sector deficit of -1.7% in Peru this year and -3% in Colombia, and forecasts an overall surplus of 0.2% in Peru next year and a deficit of -3.7% in Colombia.
Analysts also see Peru as a more politically and socially stable country than Colombia, which still has problems. Colombia is the world’s number one producer of cocaine (430 metric tonnes produced last year, according to the UN), followed by Peru (302 metric tonnes). Peru has had terrorist problem in the past, in the form of Maoist guerrilla organisation Shining Path, but now the Peruvian state is in charge of the whole national territory. In Colombia’s case, the number of guerrillas has dropped to 8000 from 30,000 but revolutionary group FARC has not yet been totally wiped out.
“Both Peru and Colombia have witnessed significant economic transformation during the past six years but they are quite different countries,” says Francisco Aristeguieta, Citi’s country officer for Colombia and regional head for the Andean region. “Colombia has a much bigger population than Peru; it has five important cities, while Peru is heavily concentrated in Lima.”
Peter Hakim, president of the Inter-American Dialogue, a Washington, DC-based think tank focusing on Latin America, says: “Peru is clearly the country among the two that has progressed the most. President Alan Garcia’s first term between 1985 and 1990 really was an economic shambles. President Alberto Fujimori’s government [between 1990 and 2000] did some pretty noxious stuff but, when he took over, the country was on its economic knees and it moved forward economically in many ways.
“Peru has really opened itself up to foreign investment and foreign trade. Colombia has come a long way but it still follows a social democratic model and has a fairly active state.”
Mr Hakim adds that the government of president Alvaro Uribe of Colombia – who was first elected in 2002 and re-elected in 2006 – has followed orthodox macroeconomic policies but it is not yet clear that the country’s political elite shares this philosophy. During President Garcia’s second term – which started in July 2006 and ends in July 2011 – Peru has become a nation of born-again capitalists and the free-market approach is shared by most members of the political establishment.
José Dario Uribe, president of Banco de la República, Columbia’s central bankJosé Dario Uribe, president of Banco de la República, Columbia’s central bank
Growth of pensions
One of the most important developments in both countries has been the growth in pension funds. According to Barclays Capital, Peru has 12 private pension funds today and the industry’s assets under management (AUM) has risen to $20.2bn today against $2.8bn in 2000. In Colombia’s case, the country has 25 pension funds today and total AUM has increased to $40bn now from $5.1bn in 2000.
The Latin American Venture Capital Association (Lavca) ranks Colombia in joint sixth best place among 13 countries in the region on its scorecard – which takes into account all the key factors affecting private equity and venture capital investment – while Peru is ranked in 11th place. Lavca says both Andean nations have liberal policies towards foreign portfolio investment by the countries’ pension funds, but Colombia scores better on its laws on fund formation and operations.
“I think Colombia is better than Peru from a private equity standpoint,” says Cate Ambrose, president of Lavca. “Colombia has a highly diversified economy: it exports flowers, coffee and high-valued added manufactures. Peru is more focused on natural resources. It could be a better investment for hedge fund managers.”
Furthermore, Colombia has outperformed Peru in terms of the amount of net inflows of FDI that it has secured: it attracted an average of $9.1bn a year between 2005 and last year, compared with an average of $3.9bn a year for Peru. During the same period, Argentina averaged $6.25bn a year, Venezuela $1.09bn, Chile $11.46bn, and Brazil $28bn.
Traditionally, Colombia has had better developed capital markets than Peru; the country had investment grade until 1999 but lost it following a severe economic meltdown in the wake of the 1997 Asian crisis. Today, total credit against GDP in Peru is 24%, compared with 30.5% in Colombia (and 60% in Chile).
However, the Peruvian banking system has been expanding rapidly. “Our bank has duplicated its client base to a total of 750,000 customers during the past two-and-a-half years,” says Eduardo Torres Llosa, country manager for Peru at BBVA Banco Continental, the country’s second biggest bank. “It’s true for other banks in the country, too. The middle class is expanding rapidly. Mortgage origination is increasing at 15% to 18% annually and the total stock of mortgages is now 150,000.”
Developing capital markets
Colombia and Peru enjoy much lower spreads than Venezuela and Argentina, and both Andean states have developed long-term yield curves unlike the other two countries. According to JPMorgan’s EMBI global index, on August 11, Colombia’s spread stood at 256 basis points and Peru’s was at 238bps, while Argentina’s was at 897bps and Venezuela’s was at 1019bps.
Mr Aristeguieta adds: “I think the biggest difference between, say, Ecuador and Venezuela on the one hand, and Peru and Colombia on the other hand, is that in the first two countries the state is the most important economic power, while in the second two the private sector is the main economic power.”
Peru’s central bank has $32.1bn in international reserves (the highest in Latin America, as a percentage of GDP), while Colombia’s reserves stand at about $20.8bn.
“Colombia’s capital markets have an intermediate level of development in the region,” says Mr Dario Uribe. “The debt market has seen significant advances, allowing the government and private companies to increase the amounts raised at a local level. In relation to derivatives, the forwards market has undergone a very important development in recent years. Exchange rate forwards are the most traded instrument.” H
e says the Colombian financial system is solid with high rates of capitalisation, profitability, liquidity and provisions. The solvency ratio is 14.5%, return on assets is at 2.4% and provisions as a percentage of overdue accounts are at 112.6%.
Recently, a futures market for fixed income and exchange rates was launched. The stock market is relatively small compared with other countries of the region in terms of the number of issuers, but from the perspective of stock market capitalisation as a proportion of GDP it is at an intermediate level in the region.
“To develop the capital markets, it is very important to maintain inflation at a stable and low level,” adds Mr Dario Uribe. “Furthermore, the design of appropriate regulatory frameworks must be advanced, including the implementation of codes of corporate governance, improvements in accounting practices and greater transparency.”
Colombia’s stock market has risen by 38% on the year to 10,437 points (even surpassing its peak of 10,178 points in May last year), while Peru’s market is up by 96% on the year to 13,831 (but remains way below its high of 18,094 in April last year). (These figures were taken on August 11, 2009.)
Eduardo Torres Llosa, country manager for Peru at BBVA Banco ContinentalEduardo Torres Llosa, country manager for Peru at BBVA Banco Continental
Four more years?
Colombia has presidential elections in May next year, and President Uribe has announced that he would like to run for a third term in office. However, a referendum would have to take place for this to happen and recently Congress has been proving reluctant to pass legislation for the referendum, despite President Uribe’s national popularity.
Peru will hold presidential elections in 2011, but the constitution does not allow presidents to run for two consecutive terms. In April, former president Alberto Fujimori was sentenced to 25 years in prison for human rights violations, but he remains popular with the country’s poor. Recently, his 34-year-old daughter, Keiko Fujimori, has started campaigning and could run as the presidential candidate for the right-wing party Alliance for the Future.
During the past few months, Peru has suffered from industrial action and social unrest. Many indigenous groups feel left out by the economic progress of the past five years and in June the country was rocked by clashes between the police and indigenous people in the coastal province of Bagua, which left 24 police and 10 civilians dead. Some analysts believe that President Garcia must pay more attention to the indigenous groups to stop a populist, left-wing candidate such as Ollanta Humala performing well in the next elections.
By pursuing orthodox macroeconomic policies, Colombia and Peru clearly have outperformed countries in the region with more populist governments, such as Argentina, Ecuador and Venezuela, in terms of attracting FDI inflows and portfolio investment. The two of them look set on becoming much more important emerging markets in the continent. Colombia has a bigger and much more diversified economy than Peru. However, Peru has some of Latin America’s most solid economic fundamentals and its government is aggressively attempting to insert the country deeper into the international community.