Peru bonds fall as investors worry about political instability

Peru's external debt has plummeted to historic lows as a wave of social unrest amid accelerated inflation turns a market upside down which was once famous for its resistance to an almost perpetual political crisis.

Government bonds due in 2031 fell 6 cents last week to trade to an all-time low of 88.5 cents to the dollar, boosting yields along Peru's debt curve. The nation's 100-year bond has fallen to a record 68 cents while the sun has weakened 2% in the past five days.

President Pedro Castillo is fighting to stop the riots in response to sky-high food and fuel prices, exacerbated by the war in Ukraine. There is growing pressure for him to resign, after only eight months of commencing his term and even after he recently emerged victorious from a second impeachment ballot. With five presidents in just over four years, there is a sense that Peru is becoming ungovernable.

“My concern is not a move to the left, it's just a total collapse of policy-making,” said Alvaro Vivanco, director of emerging markets strategy at NatWest Markets. “In this global fixed income environment, it's very difficult to see any value in Peru.”

Peru's dollar bonds are the second worst performing in the world so far this April, according to data compiled by a Bloomberg bond index, second only to those of Sri Lanka, which announced on Tuesday plans for suspend external debt payments. This year, bonds in Peruvian dollars have fallen by more than 10%.

RISING INFLATION

The fall reveals a market that is losing patience with Peru. Just 16 months ago, despite a period of political turmoil, the government was able to sell the 100-year bond with the lowest yield ever auctioned by an emerging market country.

What has changed in Peru is an even greater rejection of the ruling political class and rampant inflation. While consumer prices, which stand at 6.8 per cent, are below those of many Latin American and global peers, they continue to record the highest rate since 1998. That exposes real economic and fiscal risks.

The economy is projected to grow by around 3% in 2022.

A poll released Sunday by Ipsos shows that 79% of people disapprove of Congress, 76% reject Castillo's government and 63% want it to resign.

Castillo's decision earlier this month to declare a state of emergency to prevent looting and protests in the capital after large-scale strikes by truck drivers and farmers further fueled discontent.

Congress also passed a bill vetoed by Castillo to return about 42 billion soles (US$11.3 billion) to workers who contributed to a missing housing fund, and legislators are debating proposals to allow people to withdraw all of their pension savings.

INVESTMENT GRADE

Olga Yangol, Head of Emerging Markets Strategy for the Americas at Credit Agricole, noted that debt sustainability is not a concern for Peru, which reinstated its fiscal rule with a nominal fiscal deficit cap of 3.7% of gross domestic product and 38% of GDP for gross debt.

Peru still has an investment-grade rating for its debt and its spread on US Treasury bonds is among the lowest in Latin America, at 192 basis points. But those metrics may not hold up much longer, according to the economist at Barclays Capital Inc. Alejandro Arreaza and strategist Juan Prada.

“Peru is on track to lose investment grade status,” they wrote in a note. “Until now, the effect of persistent political instability on the fiscal position has been limited. However, the measures being taken by the authorities, coupled with the deterioration in growth prospects, could accelerate the weakening of fiscal metrics.”

With information from Bloomberg.

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