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Why Moody’s downgraded Peru’s credit rating and the consequences for the country

Published on September 07, 2021

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For the first time in 20 years, Peru’s credit rating was downgraded.

Even in the worst moments of political instability, such as when the country had three presidents in a week, the international rating agencies did not punish the country with a less favorable evaluation.

Last week, however, Moody’s Investors Service downgraded the country from A3 to Baa1, sending a warning signal to investors about the situation in the country governed by President Pedro Castillo.

“In a continually polarized and fractured political environment, political risk has increased, and policymaking capacity has been significantly weakened,” argued Moody’s.

“These conditions have negatively affected investor confidence and undermined Peru’s economic resilience, which has negatively affected Peru’s medium-term credit prospects,” wrote Jaime Reusche, senior analyst at the entity.

The cut comes weeks after the new president took office, making him the country’s fifth president in just three years.

The leadership of Castillo, who appeared in the elections backed by the Marxist party Peru Libre, has generated concern among the business elite about the economic route that a country considered for decades as one of the investment havens of Latin America will follow.

“The perceived lack of clarity on the policies of the new Administration, controversial cabinet appointments, tensions between the executive and legislative branches, and growing tensions within the ruling party have exposed several risks to overall governance, effectiveness of policies and credibility, “explained the credit counselor.

Peru’s local bonds have generated a loss of more than 24% to investors so far this year, the highest in emerging markets, according to data compiled by Bloomberg.

And the sun has weakened 11% in the same period, the worst performance in emerging markets after the Argentine peso.

The effects of the downgrade

Although the cut leaves Peru on par with Mexico on the credit scale, the fact that international perception changes for the first time in two decades is no small thing.

“It takes countries time to move forward, but it is very easy to go back,” said Oswaldo Molina, Executive Director of the analysis center Red de Estudios para el Desarrollo (Redes) and professor at the University of the Pacific.

The most direct consequence of the Moody’s cut is the rise in credit for the country.

That is, Peru will have to pay higher interest rates when borrowing money because it is considered riskier.

It also affects the credit conditions that entrepreneurs can obtain when they require external financing to carry out a project.

On the other hand, as it is a bad sign for national and foreign investors, “it can reduce the flow of capital to the country,” says Molina, and affect employment.

According to Diego Macera, General Manager of the Peruvian Institute of Economics (IPE), “the reduction is an additional source of disincentive for investments, it is something that contributes to the feeling of uncertainty that exists in some sectors.”

A feeling that in one way or another had been reflected in sovereign bonds and the exchange rate.

“The risk is that we enter a vicious circle in which bad expectations generate contractions in investment, affect the credit rating and that generates a snowball effect,” said Macera.

The rating cut, adds the economist, affects people in two ways.

On the one hand, as credit becomes more expensive, the public sector has less availability of resources to make investments in roads or water supply or to pay the salaries of teachers or policemen, for example.

And secondly, a reduction in business dynamism is generated, which leads to less employment, less income, less consumption capacity.

Now, “this does not happen with a single downgrade of the credit rating,” he explains, “but we do see this as the beginning of a process, the alarms go off.”

Especially at a time when the country needs to shore up the economic recovery after Peru’s historic negative growth in 2020 of 11.1% amid the Covid-19 pandemic that caused a global recession.

Despite the headwind, Moody’s highlighted that Peru’s economic activity has recovered “at a good pace” in the first half of the year, which is why it raised its GDP growth forecast to 12%.

Moody’s Risk Rating in Latin America
Qualification Countries
A1 Chile
Baa 1 Mexico Peru
Baa 2 Colombia Uruguay Panama
Ba 1 Guatemala Paraguay
Ba 2 Brazil
Ba 3 Dominican Republic
B1 Honduras
B2 Costa Rica Bolivia
B3 Nicaragua
Caa 1 El Salvador
Caa 2 Cuba
Caa 3 Ecuador
Ca Argentina
C Venezuela

 

What does the government say?

After learning about the credit downgrade, Peru’s Minister of Economy, Pedro Francke, said that “unlike other countries that have registered a reduction in their credit rating, mainly due to the weakening of their public finances due to the effects of the pandemic, Peru continues to maintain solid and sustainable public finances.”

The portfolio led by Francke, considered a moderate left-wing economist, said in a report that the adjustment made by Moody’s “is in line with the current rating that Peru has with Standard & Poor’s and Fitch Ratings (BBB +),” two other recognized risk rating agencies.

Another argument of the government is that the cut occurs in a context in which 49 emerging and developing countries and 16 countries in Latin America and the Caribbean had their credit rating downgraded between January 2020 and August 2021.

The Ministry said that the country foresees a progressive path of consolidation of the country’s fiscal deficit.

“With this, public debt would reach a maximum point of 37.4% of GDP in 2023, and then begin a downward trajectory, thereby remaining at sustainable levels.”

The other encouraging data highlighted by the government is that in the first half of the year the economy grew 20.4%, one of the highest rates in the world.

The uncertainty that exists in Peru surrounds issues such as what will happen now that the government takes the reins of the country with a cabinet that has been harshly criticized and without the certainty that the historic president of the Central Bank, Julio Velarde, will continue in charge.

Added to that is the nebula surrounding what will happen with the proposal to convene a Constituent Assembly to modify the Constitution and how the new regulations will affect the mining companies operating in the country.

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