An uncomfortable trend

Peru is witnessing unprecedented capital flight amidst political uncertainties.

Since the inauguration of Peru’s populist president Pedro Castillo in July of last year, over USD 15 billion of capital has left the country’s shores. For Peru, this is an unprecedented reflection of the degree to which markets and investors are unsettled over the administration’s incessant flip-flopping on sectors from mining to agriculture.

A political and economic consultant based in Peru said, “The outflow of capital from Peru in the second and third quarters of last year were the largest seen in over fifty years – funds equivalent to 7.4% of GDP left the country. This was driven primarily by the polarisation and uncertainty of Castillo’s political agenda, not least his promises to nationalise key industries including mining.”

“The outflow of capital from Peru in the second and third quarters of last year were the largest seen in over fifty years.”

Political and economic consultant, Peru

Since the beginning of this year, a paltry USD 6 million has poured into the Peruvian capital market. Few other developing markets in the world have recorded such lacklustre interest. The figure should be in the hundreds of millions. Capital is flowing fastest from Peru’s private pension funds (“AFPs”) which are largely sitting idly by whilst Peruvians draw large sums from them as the government looks to pump cash into the economy.

The AFP drain – withdrawals are currently set at 25% – is a major concern given creeping inflationary pressures. But it’s not all unwelcome news, the country’s dollar-based products are near all-time highs in terms of production and pricing. If political and policy uncertainties subside, so market sentiment and tax revenues should improve. For the time being, however, the intransigent challenge for Peru’s capital markets is the lack of anchor investors.

The consultant said, “The outlook is grim. The capital flight of USD 15 billion is driven by protracted political instability. Julio Velarde, Governor of Peru’s Central Bank (‘BCRP’) has stated that private investment is virtually zero for next year. The only way to generate income and permanent employment is through growth. For that to happen, we need private investment and political credibility, we are not creating an environment of stability.”

“We need private investment and political credibility, we are not creating an environment of stability.”

Political and economic consultant, Peru

On the economic front, the BCRP raised the policy rate to 3%, time will tell whether this is sufficient to stem creeping inflation. The BCRP has stated that this is just the beginning of a tightening cycle, additional rate hikes would continue in the coming months making capital-intensive investments an unattractive option at this time.

True, GDP growth has returned after taking a battering by the pandemic. However, this has more to do with the regularisation of day-to-day activities than to a raft of new investments and job creation. Worryingly, private, and foreign direct investment is expected to decrease in 2022 due mainly to political uncertainty. The PEN has appreciated recently after a steep devaluation last year. The BCRP expects the country’s economy to grow by 3.4% in 2022 and has forecast that the fiscal deficit will fall to 2.8% in 2022 from 3.1% in 2021.

Ironically, it is congressional gridlock – legislative opposition to Castillo’s more radical economic reforms – that has signalled to investors that common sense is not yet lost in Peru. Indeed, in a positive sign forcing the administration to adopt a more pragmatic approach to management of the economy has caused capital flight to ease just slightly since the beginning of the year.

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